Contesso Travel Inns Ltd. is a successful Canadian-controlled private corporation that owns and operates a small chain of eight hotels in western Canada. The hotels offer high-quality lodging at economy rates and provide only limited services to their guests. Contesso has succeeded because of its unique approach to the lodging industry and its strong hotel management expertise. The company has designed and constructed all of its existing units€”in fact, a sister corporation owned by the same shareholders (Contesso Developments Ltd.) maintains a small staff whose sole function is to develop new hotels. Contesso Developments has made a profit on each of the eight hotels it has developed over the past five years.
Contesso€™s success has been noticed in the hotel industry, and a number of similar hotels have sprung up across the country. The executives of Contesso realize that a race is on and that a number of other companies will be competing for the most suitable sites for expansion. They estimate that within eight years, the number of remaining quality sites will decline considerably as more hotels are developed across the country.
Contesso seriously considered going public and raising a large amount of capital to embark on a major expansion program. However, it rejected this proposal because it would have had to give up a significant percentage of its equity and because it could not project a realistic expansion plan in view of the increasing competition. At the same time, the company cannot expand rapidly while still owning each new hotel, as each unit requires more than $2,000,000 in equity capital as well as mortgage financing.
Contesso, therefore, has decided to concentrate on its two strengths€”hotel management and hotel development€”and to permit outside investors to own each unit. The expansion plan is as follows:
€¢ Contesso will identify and secure the right to acquire suitable sites.
€¢ The equity requirement for each new hotel is approximately $2,000,000. This will be obtained for each project by the issuing of 200 ownership units to private investors. Each investor may acquire any number of the 200 units. Contesso will receive a fee for organizing the investors and issuing the ownership units.
€¢ Contesso Developments will develop the hotels and assist with the acquisition of all equipment. In addition, the company will arrange mortgage financing for a fee.
€¢ Each hotel will be managed by Contesso under a long-term contract (12 years) in exchange for a fee of 5% of the hotel€™s gross revenue.
Contesso€™s executives are satisfied that this plan will result in rapid expansion and, as well, provide their company with significant income from management fees and development profits. Also, after the expansion program is complete, the company will be in a solid position to acquire ownership of the hotels if the outside investors wish to sell. Each new hotel will be sold to a different investor group in a different city, and the company executives are uncertain about which organization structure to choose. Each new hotel could be organized as a separate corporation, in which case 200 common shares would be issued; or each could be organized as a limited partnership, in which case 200 limited partnership units would be issued.
Financial information relating to each expansion unit is provided in Exhibits I and II.
Required:
Prepare an analysis of the financial information and advise Contesso which organization structure will be most attractive to prospective investors for each of the hotel units.

Transcribed Image Text:

EXHIBIT I CONTESSO TRAVEL INNS Financial Requirements and Cost Allocations 1. Project cost and financing Cost: Land, building, equipment, and start-up costs Financing 1st mortgage (35-year amortization) interest at 12% $2,500,000 Investors' contributions: 200 X $10,000 2,000,000 2. Cost allocations Land Building Furniture and equipment Landscaping Linens and supplies Costs of arranging mortgage Opening advertising and staff training Agent's fees for selling equity units Expense of issuing units (prospectus, legal, etc.) S 400,000 2,600,000 500,000 50,000 90,000 70,000 290,000 350,000 150,000 EXHIBIT II CONTESSO TRAVEL INNS Anticipated Operating Information Year Average room rate Occupancy percentage Gross revenue Operating profit before debt 4 46 70% S400,000* S900,000 $1,100,000 S1,200,000 1* 40 60% 42 63% 66% service and depreciation 200,000 400,000 480,000 520,000