Long Island Transport Group Inc. (LITGI) is a transport operator in the USA. The company operates bus services in the long Island area. LITGI is listed on the New York Stock Exchange and has a financial year end of 30 April.

The companys strategy is to expand its operations into the New York metropolitan area. LITGIs normal policy is to operate contracts of not less than ten years duration. It also seeks to include opt out clauses in any contract. Such clauses allow LITGI to withdraw from unprofitable contracts without incurring penalty charges. The board of directors at LITGI are considering a capital investment decision. You are a Corporate Finance Manager at the company. Assume that todays date is 30 April 2022.

The bus division is bidding for a new three-year contract to operate a number of bus routes in the New York metropolitan area. The contract is being awarded by a local authority in the New York metropolitan area. The contract does not include an opt out clause: the successful bidder will be committed to operate the bus routes for the full duration of the contract. The contract covers the period 1 May 2022 to 30 April 2025.

Your colleagues have produced the following estimates of the income and expenditures (as at 30 April 2022 prices) that will arise as a result of the contract.

Years to 30 April	2023 ($)	2024 ($)	2025 ($)
Fares	918,400	2,250,000	3,450,000
Fuel costs	(432,000)	(446,400)	(489,600)
Other costs (see note)	(755,000)	(840,000)	(905,000)
Profit/(loss) before taxation	(268,600)	963,600	2,055,400

Note: The Company is considering the hire of eight extra buses to operate the new contract. The annual hire cost per bus is $45,000; this is an allowable expense in the calculation of taxable profit. These amounts have been included in other costs in the Table above.

As an alternative to the plan to hire the eight new buses, the board of directors are considering purchasing the buses. Each bus would cost $200,000 (as at 30 April 2022 prices). It is estimated that the market value of each bus will be $50,000 (as at 30 April 2022 prices) at the end of the contract. However, the market for used buses is notoriously unreliable: this $50,000 estimate needs to be treated with care. LITGIs policy is to use the straight-line method of depreciation.

The board of directors estimate that all costs (except the hire of the buses and depreciation) will increase by 3% per year. Fare increases will be capped at 2% per year.

The corporate tax rate on company profits in Long Island is 21% per year. This is not expected to change during the life of the contract. Tax payable must be paid in the same year as the cash flows that gave rise to that tax payable.

LITGI uses a cost of capital of 10% for capital investment appraisal purposes. Assume that, unless told otherwise, all cash flows occur at the end of a financial year.

Task

Calculate the net present value of the two proposals (bus hire or bus purchase) and advise the board of directors on which of the two proposals it should accept.