The City of Craston has recently turned its attention to the apparent problem of a shortage of public transportation. In the last few years, more and more complaints have surfaced regarding inadequate bus services or difficulties in obtaining taxi services in the suburbs.

To operate a taxi in the city requires a special licence, which the city council's Taxi Commission issues. The Commission has issued no new licences since a freeze was instituted in 1995. There are currently only 1,750 licences still in use out of 4,500. The freedom exists, however, to transfer ownership of a licence. Such transactions have been recently quoted at $1,750 on the open market.

The addition of an airport on the outskirts of the city and three hotels in the city has created an apparent shift by taxi drivers to the core of the city and to the airport routes, resulting in poor services in the suburban areas. In contemplating this situation, the City of Craston recognizes two viable alternatives to correct the problem. Either the city can increase the number of buses serving the suburban areas, or it can issue additional taxi licences.

The Commission regulates taxi fares. Tax revenues are currently being collected from taxi drivers at a rate of 3% of gross revenues. The average trip is estimated to be 10 km. This year, the fare consists of a $1.10 flat rate plus $0.50 for every kilometre. It has been determined that each taxi driver collects revenues from 19,200 trips per year. The City estimates that in order to get the desired results, it would have to issue 85 licences at the given open market price. In addition, an incentive of $0.10 per kilometre would have to be placed on the flat rate trips origi- nating in the suburban areas to attract taxi drivers. Accordingly, the ratio of suburban to core city and airport trips would be 1 to 4.

The other alternative cited above is to increase the number of buses serving the suburban areas. Public transit fares are $1 per ride. The City estimates that if it increased the number of buses, at a cost of $1.4 million, the number of single trips would increase by 1.5 million per year. The buses would have an expected life of five years, at which time their combined salvage value would equal $100,000. The buses would be depreciated on a straight-line basis. For the duration of five years, five additional workers would have to be employed, each at an annual salary of $30,000, and maintenance costs would increase by $36,000 per year.

So far, investigation of these alternatives has revealed that if additional taxi licences are issued, the public transit revenues will drop by $350,000 per year.

Instructions

The City of Craston has asked you to evaluate the two proposals and provide a recommendation. In your analysis, assume that the rates charged for public transit and taxi fares will remain constant for the five-year period and that all cash flows occur at year end. The City of Craston currently has a 13% required rate of return.