Profits have been decreasing for several years at Pegasus Airlines. In an effort
ID: 2443593 • Letter: P
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 (165 seats × 40%
occupancy × $205 ticket price) $13,530 100.0%
Variable expenses ($11 per person) 726
Contribution margin 12,804
94.6%
Flight expenses:
Salaries, flight crew 1,770
Flight promotion 610
Depreciation of aircraft 1,530
Fuel for aircraft 5,610
Liability insurance 4,290
Salaries, flight assistants 1,310
Baggage loading and flight preparation 1,550
Overnight costs for flight crew and
assistants at destination 240
Total flight expenses 16,910
Net operating loss $(4,106)
--------------------------------------------------------------------------------
The following additional information is available about flight 482:
a. Members of the flight crew are paid fixed annual salaries, whereas the flight assistants are paid based on the number of round trips they complete.
b. One-third of the liability insurance is a special charge assessed against flight 482 because in the opinion of the insurance company, the destination of the flight is in a "high-risk" area. The remaining two-thirds would be unaffected by a decision to drop flight 482.
c. The baggage loading and flight preparation expense is an allocation of ground crews' salaries and depreciation of ground equipment. Dropping flight 482 would have no effect on the company's total baggage loading and flight preparation expenses.
d. If flight 482 is dropped, Pegasus Airlines has no authorization at present to replace it with another flight.
e. Aircraft depreciation is due entirely to obsolescence. Depreciation due to wear and tear is negligible.
f. Dropping flight 482 would not allow Pegasus Airlines to reduce the number of aircraft in its fleet or the number of flight crew on its payroll.
Required:
By how much will the profits increase or decrease if flight 482 is discontinued? (Input the amount as positive value. Omit the "$" sign in your response.)
Profits would decrease or increase by $
Explanation / Answer
We look at the expenses which will continue to be incurred if Flight 482 is discontinued :- Flight expenses: a. Members of the flight crew are paid fixed annual salaries S. SO Flight crew salary has no effect $1770 whereas the flight assistants are paid based on the number of round trips they complete. S. Flight asstt salary will be saved $1310 Overnight costs for flight crew and assistants at destination $240 will be saved. 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. S. So 1/3*4290 = 1430 will be saved if Flight 482 is discontinued but balance (4290-1430) = $2860 will continue to be incurred 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. S. No change. This is a fixed cost & will continue to be incurred $1550 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. S. Depreciation of aircraft 1,530 will continue 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. S. So flight crew salary will continue to be paid as in 'a' above From above, we see that below expenses are Fixed in nature & will be incurred even if Flight 482 is discontinued :- Salaries, flight crew 1,770 Depreciation of aircraft 1,530 Liability insurance 2860 Baggage loading and flight preparation 1,550 ------------------------------------------------------ Total Fixed costs : $7,710 ----------------------------------------- Variable costs are :- Variable expenses ($11 per person * 40%*165Seats)= $726 Flight promotion 610 Fuel for aircraft 5,610 Liability insurance - Destination relateed 1430 Salaries, flight assistants 1,310 Overnight costs for flight crew and assistants at destination 240 ----------------------------------------------------------------------------- Total Var costs : $9,926 ------------------------------- Now lets look at the Profitablity :- Ticket revenue (165 seats × 40%occupancy × $205 ticket price)= $13,530 Less Var costs = 9926 ----------------------------- Total Cont = $3604 Less Fixed cost = $7710 ----------------------------- Total Loss = $4106 ---------------------- SO Curentlt Flight 482 is contributing $3604 to Pegasus airlines. If Flight 482 is dropped, the Profit will decrease by $7710 which is is fixed costs which will still be incurred after dropping the flight.
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