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 (180 seats × 40%
occupancy × $185 ticket price) $13,320 100.0%
Variable expenses ($11 per person) 792
5.9

Contribution margin 12,528
94.1%

Flight expenses:
Salaries, flight crew 1,660
Flight promotion 710
Depreciation of aircraft 1,530
Fuel for aircraft 5,650
Liability insurance 4,110
Salaries, flight assistants 1,340
Baggage loading and flight preparation 1,670
Overnight costs for flight crew and
assistants at destination 200

Total flight expenses 16,870
Net operating loss $(4,342)


--------------------------------------------------------------------------------


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? (Input the amount as positive value. Omit the "$" sign in your response.)

Profits would (Click to select)decreaseincrease by $

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Worksheet Difficulty: Basic Learning Objective: 11-2

Explanation / Answer

Contribution margin lost if the
flight is discontinued                                                   ($12,950)

Flight costs that can be avoided if the
flight is discontinued:
==============================
Flight promotion                                             $710   
Fuel for aircraft                                           $5,650
Insurance Liability (1/3 × $4,110)                 $1,370
Salaries, Flight assistants                             $1,340
Overnight costs for flight
crew and assistants                                        $200         $9,270   
Net decrease in profits if the flight is discontinued       $3,680
                                                                                     =======

Irrelevant cost for the decision to drop Flight 492
=========================================
        Cost                                              Reason
Salaries, flight crew                  Fixed, no change with the drop
Aircraft depreciation                 Sunk cost, no effect
Insurance liability (2/3)             unaffected by the decision
Baggage loading and flight         Allocated cost, if not borne by 482
preparation                              then to be charged to other flights.                                                  

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