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 (100 seats × 40% occupancy × $70 ticket price) $ 2,800 100.0 % Variable expenses ($15.00 per person) 600 21.4 Contribution margin 2,200 78.6 % Flight expenses: Salaries, flight crew $ 330 Flight promotion 750 Depreciation of aircraft 460 Fuel for aircraft 180 Liability insurance 270 Salaries, flight assistants 740 Baggage loading and flight preparation 195 Overnight costs for flight crew and assistants at destination 60 Total flight expenses 2,985 Net operating loss $ (785 )

Explanation / Answer

Solution 1:

If flight is discontinued then there will be financial disadvantage of $380. Therefore flight should not be discontinued.

Computaion of Financial advantage (disadvantage) of discontinuing Flight 482 Particulars Amount Contribution Margin lost -$2,200.00 Less: Avoidable Flight costs Flight Promotion $750.00 Fuel for Aircraft $180.00 Liability Insurance $90.00 Salaries, Flight Assistants $740.00 Overnight costs for flight crew and assistants at destination $60.00 Total Avoidable flight costs $1,820.00 Net Increase (Decrease) in income -$380.00

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