Question

Profits have been decreasing for several years at Pegasus Airlines. In an effort to improve the company’s performance, consideration is being given to 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 (105 seats × 40% occupancy × $65 ticket price) $ 2,730 100.0 % Variable expenses ($15.00 per person) 630 23.1 % (rounded) Contribution margin 2,100 76.9 % (rounded) Flight expenses: Salaries, flight crew $ 300 Flight promotion 660 Depreciation of aircraft 370 Fuel for aircraft 165 Liability insurance 150 Salaries, flight assistants 720 Baggage loading and flight preparation 175 Overnight costs for flight crew and assistants at destination 70 Total flight expenses 2,610 Net operating loss $ (510) The following additional information is available about flight 482: a. 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. b. 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. c. 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. d. If flight 482 is dropped, Pegasus Airlines has no authorization at present to replace it with another flight. e. Aircraft depreciation is due entirely to obsolescence. Depreciation due to wear and tear is negligible. f. 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. Prepare an analysis showing what impact dropping flight 482 would have on the airline's profits. (Any losses/ reductions should be indicated by a minus sign.)

Answer 1

Cost	Reason
Salaries, flight crew	Fixed annual salaries, which will not change.
Depreciation of aircraft	Sunk cost.
Liability insurance (two-thirds)	Two-thirds of the liability insurance is unaffected by this decision
Baggage loading and flight preparation	This is an allocated cost that will continue even if the flight is   discontinued.
Contribution margin lost if the tour is discontinued		$   (2,100)
Less:fligts costs that can be avoided ig the flight is discontinued
Flight promotion	$                                                                                                                                                              660
Fuel for aircraft	$                                                                                                                                                              165
Liability insurance(150*1/3)	$                                                                                                                                                                 50
Salaries flight assistants	$                                                                                                                                                              720
Overnight costs for flight crew and assistants	$                                                                                                                                                                 70	$     1,665
Net increase(decrease) in profits of the flights is discontinued		$       (435)