Profits have been decreasing for several years at Pegasus Airlines. In an effort

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:

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?

Ticket revenue (165 seats × 40% occupancy × $230 ticket price) $ 15,180 100.0 % Variable expenses ($16.00 per person) 1,056 7 Contribution margin 14,124 93 % Flight expenses: Salaries, flight crew $ 1,600 Flight promotion 750 Depreciation of aircraft 1,750 Fuel for aircraft 5,100 Liability insurance 5,100 Salaries, flight assistants 1,200 Baggage loading and flight preparation 1,800 Overnight costs for flight crew and assistants at destination 700 Total flight expenses 18,000 Net operating loss $ (3,876 )

Explanation / Answer

Contribution margin lost if the tour is discontinued -$14,124 Less flight costs that can be avoided if the flight is discontinued Flight promotion $750 Fuel for aircraft $5,100 Liability insurance($5,100 * 1/3) $1,700 Salaries, flight assistants $1,200 Overnight costs for flight crew and assistants $700 $9,450 Net increase (decrease) in profitsif the flight is discontinued -$4,674

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