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, the company is thinking about 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:

The following additional information is available about flight 482:

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.

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.

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.

If flight 482 is dropped, Pegasus Airlines has no authorization at present to replace it with another flight.

Aircraft depreciation is due entirely to obsolescence. Depreciation due to wear and tear is negligible.

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:

1. What is the financial advantage (disadvantage) of discontinuing flight 482?

Ticket revenue (195 seats × 40% occupancy × $220 ticket price) $ 17,160 100.0 % Variable expenses ($16.00 per person) 1,248 7.3 Contribution margin 15,912 92.7 % Flight expenses: Salaries, flight crew $ 1,500 Flight promotion 770 Depreciation of aircraft 1,800 Fuel for aircraft 5,400 Liability insurance 5,100 Salaries, flight assistants 1,300 Baggage loading and flight preparation 1,750 Overnight costs for flight crew and assistants at destination 500 Total flight expenses 18,120 Net operating loss $ (2,208 )

Explanation / Answer

Contribution Margin Lost If Flight Is Discontinued ( $ 17,160)

Less: Flight Costs Which Can Be Avoided if flight is Discontinued

Flight Promotion $ 770

Fuel for Aircraft $5,400

Liability Insurance(1/3*5100) $1,700

Salaries Flight Assistants $1,300

Overnight costs of Flight Crew and Assistants $5,00   $9,670

If Pegasus Airlines discontinues flight 482,it's profit will go down by $ 7,490,hence it is advisable to continue

Following Costs are not Relevant to the Decision

Salaries Flight Crew-Fixed annual salaries which will not change

Baggage loading and flight preparation-This is an allocation which will continue even if flight is discontinued

  

  

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