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:

Ticket revenue (110 seats × 40% occupancy × $75 ticket price)	$	3,300			100.0	%
Variable expenses ($10.00 per person)		440			13.3
Contribution margin		2,860			86.7	%
Flight expenses:
Salaries, flight crew	$	380
Flight promotion		660
Depreciation of aircraft		370
Fuel for aircraft		185
Liability insurance		270
Salaries, flight assistants		730
Baggage loading and flight preparation		190
Overnight costs for flight crew and assistants at destination		70
Total flight expenses		2,855
Net operating loss	$	(5	)

The following additional information is available about flight 482:

1. 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.

2. 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.

3. 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.

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

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

6. 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?

Answer 1

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

Answer:

Financial disadvantage of dropping the Flight 482 = (1125)

Working notes for the above answer is as under

	Remain	Drop	Diffrance
	with 482	482
Ticket revenue	3300	0	-3300
Variable expenses	440	0	440
Contribution margin	2860	0	-2860
Flight expenses:
Salaries, flight crew	380	380	0
Flight promotion	660	0	660
Depreciation of aircraft	370	370	0
Fuel for aircraft	185	0	185
Liability insurance (270*2/3)=180	270	180	90
Salaries, flight assistants	730	0	730
Baggage loading and flight preparation	190	190	0
Overnight costs for flight crew and assistants at destination	70	0	70
Total flight expenses	2855	1120	1735
Net operating loss	5	-1120	-1125

Net decease in profit if flight is dropped is =$1125