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.

Ticket revenue (120 seats × 40% occupancy × $65 ticket price) $ 3,120 100.0 % Variable expenses ($13.00 per person) 624 20 Contribution margin 2,496 80 % Flight expenses: Salaries, flight crew $ 330 Flight promotion 730 Depreciation of aircraft 460 Fuel for aircraft 190 Liability insurance 180 Salaries, flight assistants 700 Baggage loading and flight preparation 180 Overnight costs for flight crew and assistants at destination 80 Total flight expenses 2,850 Net operating loss $ (354 )

Explanation / Answer

Contribution margin lost if the tour is discontinued ($2,496) Less flight costs that can be avoided if the flight is discontinued: Flight promotion $730 Fuel for aircraft $190 Liability insurance($180 × 1/3) $60 Salaries, flight assistants $700 Overnight costs for flight crew and assistants $80 $1,760 Net increase (decrease) in profits if the flight is discontinued ($736)

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