(Related to Checkpoint 18.2) (Calculating the cost of short-term financing) 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 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: Alternative A. The firm's 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 is not binding on the firm because it normally maintains a minimum demand deposit (checking account) balance of $25,000 in the bank. Alternative B. The equipment dealer has agreed to finance the equipment with a 1-year loan. The $100,000 loan requires payment of principal and interest totaling $116,300. a. Which alternative should Morin select? b. If the bank's compensating-balance requirement had necessitated idle demand deposits equal to 15 percent of the loan, what effect would this have had on the cost of the bank loan alternative? a. The cost of Alternative A would be %. (Round to two decimal places.)
(Related to Checkpoint 18.2) (Calculating the cost of short-term financing) 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 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: Alternative A. The firm's 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 is not binding on the firm because it normally maintains a minimum demand deposit (checking account) balance of $25,000 in the bank. Alternative B. The equipment dealer has agreed to finance the equipment with a 1-year loan. The $100,000 loan requires payment of principal and interest totaling $116,300. a. Which alternative should Morin select? b. If the bank's compensating-balance requirement had necessitated idle demand deposits equal to 15 percent of the loan, what effect would this have had on the cost of the bank loan alternative? a. The cost of Alternative A would be %. (Round to two decimal places.)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Question 4 Redo
Part 1
a. The cost of Alternative A would be _________________ %
(Round to two decimal places.)
(Round to two decimal places.)
Part 2
The cost of Alternative B would be __________________ %
(Round to two decimal places.)
(Round to two decimal places.)
Part 3
Which alternative should Morin select?
Morin Construction Company should select ______________. for financing its purchase.
Part 4
b. If the bank's compensating-balance requirement had necessitated idle demand deposits equal to 15 percent of the loan, the new cost of Alternative A (bank loan alternative) would be: __________ (Round to two decimal places.)
Transcribed Image Text:(Related to Checkpoint 18.2) (Calculating the cost of short-term financing) 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 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:
Alternative A. The firm's 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 is not binding on the firm
because it normally maintains a minimum demand deposit (checking account) balance of $25,000 in the bank.
Alternative B. The equipment dealer has agreed to finance the equipment with a 1-year loan. The $100,000 loan requires payment of principal and interest totaling $116,300.
a. Which alternative should Morin select?
b. If the bank's compensating-balance requirement had necessitated idle demand deposits equal to 15 percent of the loan, what effect would this have had on the cost of the bank loan alternative?
a. The cost of Alternative A would be %. (Round to two decimal places.)
Expert Solution
Step 1
A borrower is required to keep a minimum deposit in their bank account, described as a compensating amount. Individual loans are less likely to demand a compensating balance than corporate loans. A business can borrow money at a cheap interest rate by agreeing to a compensating balance. The compensating amount can be used to fund new loans while reducing the bank's risk of default. The compensating balance must be disclosed by the company borrower in its accounting records, usually as restricted cash.
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