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 (180 seats × 40% occupancy × $250 ticket price)	$	18,000			100.0	%
Variable expenses ($17.00 per person)		1,224			6.8
Contribution margin		16,776			93.2	%
Flight expenses:
Salaries, flight crew	$	1,800
Flight promotion		760
Depreciation of aircraft		1,800
Fuel for aircraft		6,000
Liability insurance		5,100
Salaries, flight assistants		1,300
Baggage loading and flight preparation		2,000
Overnight costs for flight crew and assistants at destination		700
Total flight expenses		19,460
Net operating loss	$	(2,684	)

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?

	Financial (disadvantage)

Answer 1

Particulars	Continue	Discontinue
Revenue	18,000	-
Variable expenses	1,224	-
Contribution	16,776	-
Other expenses:
Salaries	1,800	1,800
Flight promotion	760	-
Depreciation	1,800	1,800
Fuel	6,000	-
Liability insurance	5,100	3,400
Salaries	1,300	-
Baggage loading	2,000	2,000
Overnight costs	700	700
Total	19,460	9,700
Net income/ (loss)	(2,684)	(9,700)

Financial disadvantage = 2684-9700 = 7016

Continue flight