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 (175 seats × 40% occupancy × $220 ticket price)	$	15,400			100.0	%
Variable expenses ($15.00 per person)		1,050			6.8
Contribution margin		14,350			93.2	%
Flight expenses:
Salaries, flight crew	$	2,000
Flight promotion		780
Depreciation of aircraft		1,750
Fuel for aircraft		5,000
Liability insurance		5,100
Salaries, flight assistants		1,300
Baggage loading and flight preparation		1,750
Overnight costs for flight crew and assistants at destination		700
Total flight expenses		18,380
Net operating loss	$	(4,030	)

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

Solution:

Financial advantage (disadvantage) of discontinuing flight 482:

Contribution on Flight 482 (Given) = $14,350

If we discontinue Flight 482 there will be a loss of the contribution

Particulars	Workings	Amount ($)
Loss of Contribution	Given	(14,350)
Avoidable costs if the flight is discontinued (Savings)
Flight promotion	Given	780
Fuel for aircraft	Given	5,000
Liability Insurance	1/3*5100	1,700
Salaries, flight assistants	Given	1,300
Overnight costs for flight crew and assistants	Given	700
Net decrease in profit		(4,870)

*Members of the flight crew are paid fixed annual salaries hence no effect in discontinuing the flight

*Dropping flight 482 would have no effect on the company’s total baggage loading and flight preparation expenses, hence not relevant in decision.

*Two-thirds would be unaffected by a decision to drop flight 482 thus 1/3 are related to this decision and the same is considered.

Hence If the flight 482 is discontinued the financial disadvantage is $4,870