Answer (A) is correct . The most desirable set of terms are those that result in the lowest cost of borrowing. Discount interest results in a higher effective borrowing cost than simple interest because the bank deducts interest in advance so the borrower receives less than the face value of the loan. A compensating balance results in a higher effective borrowing cost because the compensating balance is an amount of cash that the firm is unable to use. The cheapest terms, given that all options have the same nominal interest rate, will be simple interest with no compensating balance.
Answer (B) is incorrect because Discount interest results in a higher effective borrowing cost than simple interest because the bank deducts interest in advance so the borrower receives less than the face value of the loan.
Answer (C) is incorrect because A compensating balance results in a higher effective borrowing cost because the compensating balance is an amount of cash that the firm is unable to use.
Answer (D) is incorrect because Discount interest and a compensating balance are disadvantageous to the borrower.
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