The R. Morin Construction Company needs to borrow $100,000 to help finance the cost of a new $150,000 hydraulic crane used in the firms commercial construction business. The crane will pay for itself in 1 year, and the firm is considering the following alternatives for financing its purchase:

Alternative AThe firms bank has agreed to lend the $100,000 at a rate of 14 percent. Interest would be discounted and a 15 percent compensating balance would be required. However, the compensating-balance requirement would not be binding on R. Morin because the firm normally maintains a minimum demand deposit (checking account) balance of $25,000 in the bank.

Alternative BThe equipment dealer has agreed to finance the equipment with a 1-year loan. The $100,000 loan would require payment of principal and interest totaling $116,300.

Required:

1.Which alternative should R. Morin select?

2.If the banks compensating-balance requirement were to necessitate idle demand deposits equal to 15 percent of the loan, what effect would this have on the cost of the bank loan alternative?