Question

Charlotte Lebioda grew up in the hotel business. Her parents owned and operated a 100-room limited-service hotel for 20 years. When Charlotte graduated from hospitality school, her parents retired, turning the business over to Charlotte. Her hotel has an appraised value of $3,000,000 and total mortgage debt of $1,000,000, and her initial equity was $2,000,000. The franchisor with which Charlotte's property is associated has approached her to see if she wants her to develop a second property to be located ten miles from the original hotel. The franchisor is proposing a 100-room property, which can be built at a cost of $4,000,000. In addition, the franchisor has indicated that a special financing arrangement has been put in place that allows existing franchisees to obtain 100% financing if their current properties score in the top 10% of the franchisor's annual inspection program. Charlotte's property qualifies for the special financing offer. 1. Develop The Accounting Formula for Charlotte's hotel as it exists prior to constructing the new hotel. 2. Develop The Accounting Formula for Charlotte's two properties, as it would exist if she built the new hotel. 3. Assume you were advising Charlotte. What would you tell her about the impact of the new hotel on the assets, liabilities, and owners' equity portions of her new Accounting Formula? What do you believe are the key factors Charlotte should consider before agreeing to build the new property?

Answer 1

3. The debt/equity for the company will increase from comfortable 0.5x to high 2.5 level due to incremental debt.

Charlotte should consider the second hotel in just 10 miles from existing property only if occupancy in existing hotel is more than 85-90% as it may have cannibalization effect on occupancy level of existing hotel as some of the customers may go to new hotel.

Further, she need to see if the debt servicing would be comfortable after new incremental debt from projected profitability.

I Existing Hotel Liabilities Equity Debt Balance Sheet I Amonit 2,000,000 Hotel 1,000,000 Assets Asset Anomb 3000,000 3,000,000 3,000,000 2. Existing & New Hotel Balance Sheet 2o00ooo I Hotel Assets 17000000 Equity Debt 5,000,000 17,000,000 17,000,000