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 (200 seats × 40% occupancy × $210 ticket price) $ 16,800 100.0 % Variable expenses ($15.00 per person) 1,200 7.1 Contribution margin 15,600 92.9 % Flight expenses: Salaries, flight crew $ 1,500 Flight promotion 790 Depreciation of aircraft 1,700 Fuel for aircraft 5,700 Liability insurance 4,800 Salaries, flight assistants 1,200 Baggage loading and flight preparation 1,950 Overnight costs for flight crew and assistants at destination 500 Total flight expenses 18,140 Net operating loss $ (2,540 ) The following additional information is available about flight 482: 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. 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. 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. If flight 482 is dropped, Pegasus Airlines has no authorization at present to replace it with another flight. Aircraft depreciation is due entirely to obsolescence. Depreciation due to wear and tear is negligible. 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

Impact dropping flight 482 would have on the airline's profits.

Particular	flight 482 Continued	flight 482 not Continued	Increse/ (decrease)
Ticket revenue (200 seats x 40%	16800		-16,800
occupancy x$210 ticket price)
Variable expenses ($15 per person)	1200		1,200
Contribution margin	15600	0	-15,600
Flight expenses:
Salaries, flight crew	1500	1500	0
Flight promotion	790		790
Depreciation of aircraft	1700	1700	0
Fuel for aircraft	5700		5,700
Liability insurance	4800	3200	1,600
Salaries, flight assistants	1200		1,200
Baggage loading and flight preparation	1950	1950	0
Overnight costs for flight crew and	500		500
Total flight expenses	18140	8350	9790
Net operating loss	-2540	-8350	-5,810

If flight 482is droopped then Net operating loss will be incresed by $5810