Profits have been decreasing for several years at Pegasus Airlines. In an effort

Question

Profits have been decreasing for several years at Pegasus Airlines. In an effort to improve the company's performance, consideration is being given to dropping several flights that appear to be unprofitable.


A typical income statement for one round-trip of one such flight (flight 482) is as follows:


Ticket revenue (175 seats × 40%
occupancy × $200 ticket price) $14,000 100.0 %
Variable expenses ($15 per person) 1,050 7.5
Contribution margin 12,950
92.5 %

Flight expenses:
Salaries, flight crew 1,800
Flight promotion 750
Depreciation of aircraft 1,550
Fuel for aircraft 5,800
Liability insurance 4,200
Salaries, flight assistants 1,500
Baggage loading and flight preparation 1,700
Overnight costs for flight crew and
assistants at destination 300

Total flight expenses 17,600
Net operating loss $(4,650)


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The following additional information is available about flight 482:
a. Members of the flight crew are paid fixed annual salaries, whereas the flight assistants are paid based on the number of round trips they complete.
b. One-third of the liability insurance is a special charge assessed against flight 482 because in the opinion of the insurance company, the destination of the flight is in a "high-risk" area. The remaining two-thirds would be unaffected by a decision to drop flight 482.

c. The baggage loading and flight preparation expense is an allocation of ground crews' salaries and depreciation of ground equipment. Dropping flight 482 would have no effect on the company's total baggage loading and flight preparation expenses.

d. If flight 482 is dropped, Pegasus Airlines has no authorization at present to replace it with another flight.
e. Aircraft depreciation is due entirely to obsolescence. Depreciation due to wear and tear is negligible.
f. Dropping flight 482 would not allow Pegasus Airlines to reduce the number of aircraft in its fleet or the number of flight crew on its payroll.

Required:
By how much will the profits increase or decrease if flight 482 is discontinued?

Explanation / Answer

If the flight is discontinued, clearly the contribution margin of 12,950 will be lost. From the text it appears the following costs would be eliminated if the flight is dropped. Flight promotion 750 1/3 of liability insurance 1,400 Flight assistant salaries 1,500 Overnight costs 300 Fuel for aircraft 5,800 Total 9,750 So the loss on dropping the flight will be 12,950-9,750=3,200

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