Southern Airlines is considering a proposal to initiate air service between Phoe

Question

Southern Airlines is considering a proposal to initiate air service between Phoenix and Las Vegas. The route would be designed primarily to serve the tourist travelers (gamblers) that frequently travel between the two cities. By offering low cost tourist fares, the airline hopes to persuade persons who now travel by other modes of transportation to switch and fly Trans Western on this route. In addition, the airline expects to attract business travelers during the hours of 7 AM to 6 PM on Mondays through Fridays The fare schedule would be designed to charge a higher fare during business-travel hours so that tourist demand would be reduced during those hours. The company believes that a business fare of $40 one way during business hours and a fare of S30 for all other hours would result in the passenger load being equal during business-travel hours and tourist-travel hours. The airline will operate five business flights and three tourist flights each way every weekday, and ten tourist flights (but no business flights) each way every Saturday and Sunday To operate the route, the airline would need two 120-passenger jet aircraft. The aircraft would be leased at an annual cost of $2,800,000 each. Other fixed costs for ground services would amount to S1,940,000 per year (assume there are exactly 52 weeks in a year). Operation of each aircraft requires a flight crew whose salaries are based primarily on flying time. The costs of each flight crew are approximately S600 per hour of flying time. Fuel costs are estimated at $210 per hour of flying time. Flying time between Phoenix and Las Vegas is estimated at 45 minutes each way The costs associated with processing each passenger amount to $7 per flight (i.e., a return flight costs $14). This includes ticket processing, agent commissions, and variable costs of baggage handling. Any cost of food-and-beverage service is expected to be fully recovered through the charges levied for alcoholic beverages.

Explanation / Answer

a. Classification of costs as fixed or variable

i. Annual Lease cost of two jet aircrafts - This is a fixed cost as it will remain the same whether the passengers travel or not and therefore is independent of the flying time.

ii. Fixed Costs for Ground Services - Ground services are fixed costs as they will be incurred irrespective of the flying time of the jet aircrafts. These costs are bound to happen once the aircrafts are leased. And will remain constant through out the year.

iii. Salaries of flight cost - These are variable costs as the same are directly dependent upon the flying time of each crew member. These costs vary with the amount of flying time of each crew member.

iv. Fuel Costs - Fuel cost is a variable cost which is incurred only when the aircraft flies. It is incurred on the basis of the flying time. Higher the flying time of the aircraft, higher will be the fuel costs.

v. Costs associated with processing each passenger - It is a variable cost which is varies with the number of passengers travelling. These costs are directly related to the number of passengers travelling.

b. Total number of tourist Flights & Business Flights offerred per week

Total Tourist Flights = (3 flights each day x 2 round trip x 5 days a week) + (10 flights each day x 2 round trips x 2 days a week)

= 30 flights + 40 flights = 70 flights per week

Total Business Flights = (5 flights each day x 2 round trips x 5 days a week)

= 50 Flights per week.

Total Flights offerred = 120 flights per week.

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