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 (115 seats × 40% occupancy × $60 ticket price) $ 2,760 100.0 % Variable expenses ($14.00 per person) 644 23.3 Contribution margin 2,116 76.7 % Flight expenses: Salaries, flight crew $ 340 Flight promotion 710 Depreciation of aircraft 530 Fuel for aircraft 200 Liability insurance 210 Salaries, flight assistants 680 Baggage loading and flight preparation 185 Overnight costs for flight crew and assistants at destination 70 Total flight expenses 2,925 Net operating loss $ (809 )

Explanation / Answer

Avoidable costs & revenues Unavoidable costs Ticket revenue (115 seats × 40% occupancy × $60 ticket price) 2,760 -2760 Relevant revenue Variable expenses ($14.00 per person) 644 644 relevant cost Contribution margin 2,116 -2116 Relevant revenue Flight expenses: Salaries, flight crew 340 340 Giong to be incurred anyway Flight promotion 710 710 Giong to be incurred anyway Depreciation of aircraft 530 530 Giong to be incurred anyway Fuel for aircraft 200 200 relevant cost Liability insurance 210 70 140 relevant cost Salaries, flight assistants 680 680 relevant cost Baggage loading and flight preparation 185 185 Giong to be incurred anyway Overnight costs for flight crew and assistants at destination 70 70 Giong to be incurred anyway Total flight expenses 2,925 -1166 1975 Net operating loss -809 Ticket revenue 2760 Less:All variable & relevant costs (644+200+70+680) 1594 Contribution /round-trip 1166 Unavoidable fixed costs 1975 Net loss (1166-1975) -809 Revenues lost net of costs- that- can- be- saved if 482 is dropped= 1166 Costs that wil be incurred irrespective of the decision= 1975 So, total costs (loss)of dropping= 1166+1975= 3141 If Flight 428 is operated ,it will generate a contribution of 1166 to meet the unaviodable costs of 1975 ,so as to reduce the NET LOSS to 809 --- which would otherwise be $ 3141 So, it is recommended to continue to operate Flight 482,, as it is provides a major contribution towards meeting the fixed costs.

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