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 (190 seats × 40% occupancy × $220 ticket price)	$	16,720			100.0	%
Variable expenses ($17.00 per person)		1,292			7.7
Contribution margin		15,428			92.3	%
Flight expenses:
Salaries, flight crew	$	1,600
Flight promotion		790
Depreciation of aircraft		1,750
Fuel for aircraft		5,400
Liability insurance		5,100
Salaries, flight assistants		1,400
Baggage loading and flight preparation		1,750
Overnight costs for flight crew and assistants at destination		700
Total flight expenses		18,490
Net operating loss	$	(3,062	)

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.

Answer 1

The net benefit of dropping flight = fixed costs avoided - contribution margin lost

= flight promotion expense +fuel+1/3*liability insurance +salaries of flight assistants +overnight cost at destination - 15,428

= 790+5,400+1/3*5,100 +1,400+700 - 15,428

=-$5,438

Hence, dropping flight will lead to fall in profits by $5,438

Note: depreciation, baggage, flight crew expenses will not decrease after dropping flight and hence, irrelevant