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. An income statement for one round-trip of one such flight (flight 482) is as follows:

Ticket revenue (175 seats × 40% occupancy × $200 ticket price) $14,000 100.0%

Variable expenses ($15 per person) 1,050 7.5

Contribution margin 12,950 92.5%

Flight expenses: Salaries, flight crew $ 1,800

Flight promotion 750

Depreciation of aircraft 1,550

Fuel for aircraft 5,800

Liability insurance 4,200

Salaries, flight assistants 1,500

Baggage loading and flight preparation 1,700

Overnight costs for flight crew and assistants at destination 300

Total flight expenses 17,600

Net operating loss $(4,650) 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.

Questions

1. What is the financial advantage (disadvantage) in dollars of discontinuing flight 482? Please provide details for your conclusion.

2. What costs are not relevant to your decision? Explain why.

3. The airline’s scheduling officer has been criticized because only about 50% of the seats on Pegasus’ flights are being filled compared to an industry average of 60%. The scheduling officer has explained that Pegasus’ average seat occupancy could be improved considerably by eliminating about 10% of its flights, but that doing so would reduce profits. Explain how this could happen.

Answer 1

1	Financial advantage (disadvantage):
							$	$
	Contribution lost due to elimination of flight 482							-12950
	Add:
	Flight promotion						750
	Fuel for aircraft						5800
	Liability insurance			(4200*1/3)			1400
	Salaries,Flight assistants						1500
	Overnight costs for flight crew and assistants at destination						300	9750
	Financial advantage (disadvantage)							-3200
	Flight 482 should not be dropped since it results in a financial disadvantage of $ 3200
2	Costs not relevant to decision:
	Cost				Why?
	Salaries,flight crew				Fixed cost and will continue
	Depreciation of aircraft				Sunk cost
	Liability insurance (Two-third)				This part of the insurance is common to the Airline
	Baggage,loading and flight preparation				Allocated cost and will continue
3	Eliminate flights with very low occupancy.
	It may encourage passengers to choose other available flights of the airline.
	It will increase the occupancy of remaining flights
	I appreciate your ratings