Wonder Amusements Limited (WAL) was incorporated over 40 years ago as an amusement park and golf course. Over time, a nearby city has grown to the point where it borders on WAL’s properties. In recent years WAL’s owners, who are all members of one family, have seen WAL’s land values increase significantly. WAL’s majority shareholder, Howard Smith, owns 55% of the outstanding shares and is no longer active in WAL’s day- to- day activities.
Last year Howard hired a new chief executive officer, Leo Titan. Leo has a reputation for being an aggressive risk taker. Howard is committed to supporting Leo’s plans and has the personal financial resources required to do so.
Eight months ago, WAL became the successful bidder for a new sports franchise, in con-junction with a minority partner. Under the terms of the franchise agreement, WAL is required to build a sports arena, which is currently being constructed. The arena is being built on a section of the amusement park. Another section of the amusement park is being relocated to ensure that the entrances to the arena are close to public transportation and parking. Consequently, some of the rides will be relocated. WAL is the sole owner of the arena at present.
The sports franchise is separately incorporated as Northern Sports Limited (NSL); WAL holds 75% of the shares in the company. Another bid is being prepared by NSL to obtain a second sports franchise so that the arena can be used more often. NSL will be required to lease space from WAL when the arena is completed, in about 22 months. For the first two sports seasons, NSL will have to lease arena space from Aggressive Limited (AL). During this time, NSL does not expect to be profitable because:
• It may take time to build a competitive team;
• AL is charging a high rent and is not giving NSL a share of concession ( e. g., hot dogs, drinks) revenue;
• AL cannot make the better dates ( e. g., Saturday night) available to NSL to attract sports fans; and
• As a newcomer to the league, NSL is restricted with regard to the players who are avail-able to it and the days of the week it can play in its home city. Consequently, NSL has arranged to borrow funds from WAL and from others to finance costs and losses.
In your review of documents, and as a result of various conversations, you have learned the following:
1. The arena will be mortgaged, but only for about 50% of its expected cost. Lenders are concerned about the special- use nature of the arena and whether it will be successfully rented for other events, such as concerts.
2. The mortgage lenders to WAL and the minority shareholders in NSL are both expected to want to see appraisals and financial statements before deciding whether to invest. Covenants will be required by the lenders to ensure that excessive expenditures are not undertaken and that cash is preserved.
3. Leo does not intend to consolidate NSL until it is profitable. The investment in NSL will be reported on WAL’s financial statements at cost. The WAL financial statements will be used for income tax purposes.
4. WAL’s minority shareholders are not active in the business and want quarterly financial statements to monitor progress and assess Leo’s performance. The minority shareholders have all expressed concern over Leo’s growth strategy over the past year. Most are approaching their retirement years and are relying on WAL to supplement their retirement income.
Prepare the report.