The R. Morin Construction Company needs to borrow $90,000 to help finance the co

Question

The R. Morin Construction Company needs to borrow $90,000 to help finance the cost of a new

$135,000 hydraulic crane used in the firm's commercial construction business.

The crane will pay for itself in one year, and the firm is considering the following alternatives for financing its purchase:

A: The firm's bank has agreed to lend the

$90,000 at a rate of 12 percent. Interest would be discounted, and 15 percent compensating balance would be required. However, the compensating-balance requirement is not binding on the firm because it normally maintains a minimum demand deposit (checking account) balance of$22500 in the bank.

B: The equipment dealer has agreed to finance the equipment with a 1-year loan. The $90,000 loan requires payment of principal and interest totaling $104,328

The cost of Alternative A would be %?. (Round to two decimal places.)

The cost of Alternative B would be %?. (Round to two decimal places.)

Which alternative should Morin select?

b. If the bank's compensating-balance requirement had necessitated idle demand deposits equal to 16 percent of the loan, the new cost of Alternative A (bank loan alternative) would be ?

Therefore, R. Morin Construction Company should select WHICH Alternative?

Explanation / Answer

A:-

Cost of alternative A:-

Cost of alternative B:-

= ($104,328/$90,000)-1

= 1.1592-1

= 0.1592*100

= 15.92%

Cost of alternative B IS 15.92%.

B:-

= 12/(1-15)

= 14.12%

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