Relevant Information for Decision Making, Case Study Example

Relevant Costing Problems

Westcoast Air Co. leases a single jet aircraft and operates between San Francisco and the Fiji.  Flights leave San Francisco on Mondays and Thursdays and depart from Fiji on Wednesdays and Saturdays.  Westcoast Air Co. cannot offer any more flights between San Francisco and Fiji.  Only tourist-class seats are available on its planes.  An analyst has collected the following information:

Seating capacity per plane: 380 passengers

Average number of passengers per flight: 175 passengers

Flights per week: 4 flights

Flights per year: 208 flights

Average one-way fare: $325

Variable fuel costs: $14,000 per flight

Food and beverage service costs/passenger: $4 per

Commission to travel agents paid by Air Frisco: 10% of fare (all tickets are booked by travel agents)

Fixed annual lease costs allocated to each flight: $53,000 per flight

Fixed ground services (maintenance, check in, baggage handling) costs allocated to each flight: $7,500 per flight

Fixed flight crew salaries allocated to each flight: $7,000 per flight

Required:

1. Calculate the operating income that Westcoast Air earns on each one-way flight between San Francisco and Fiji.
2. The Market Research Department of Westcoast Air indicates that lowering the average one-way fare to $280 will increase the average number of passengers per flight to 212.  Should the company lower its fare?  Show your calculations.
3. Travel International, a tour operator, approaches Westcoast Air on the possibility of chartering (renting out) its jet aircraft twice each month, first to take Travel International’s tourists from San Francisco to Fiji and then to bring the tourists back from Fiji to San Francisco.  If Westcoast Air accepts Travel International’s offer, Westcoast Air will be able to offer only 184 (208 – 24) of its own flights each year.  The terms of the charter are as follows: (a) For each one-way flight, Travel International will pay Westcoast Air $75,000 to charter the plane and to use its flight crew and ground service staff; (b) Travel International will pay for fuel costs; and (c) Travel International will pay for all food costs.  On purely financial considerations, should Westcoast Air accept Travel International’s offer?  Show your calculations.  What other factors should the company consider in deciding whether or not to charter its plane to Travel International?

Modular Case Assignment Expectations:

Summarize your findings in a report which answers the above questions.  The submission should be 2 to 4 pages and need to include income statements and other computations in good format as well as a discussion interpreting the analysis.  Answer all questions and include references in APA format.

Relevant Costing Problem Solving

Requirement # 1

Sales (325*175): 56875.0

Variable cost

Fuel cost: (14000)

Food and beverages cost (4*175): (700)

Commission paid to travel agents (10%*56875): (5687.5)

(20387.5)

Contribution: 36487.5

Fixed Cost

Fixed annual lease costs allocated to each flight: (53,000)

Fixed ground services (maintenance, check in, baggage handling) costs allocated to each flight: (7,500)

Fixed flight crew salaries allocated to each flight: (7,000)

(67500.0)

Net loss per flight: (31012.5)

Requirement # 2

Sales (280*212): 59360.0

Variable cost

Fuel cost: (14000)

Food and beverages cost (4*212): (848)

Commission paid to travel agents (10%*59360): (5936)

(20784.0)

Contribution: 38576.0

Fixed Cost

Fixed annual lease costs allocated to each flight: (53,000)

Fixed ground services (maintenance, check in, baggage handling) costs allocated to each flight: (7,500)

Fixed flight crew salaries allocated to each flight: (7,000)

(67500.0)

Net loss per flight: (28924.0)

On the basis of numeracy aspect only, Westcoast Air should opt to reduce its fare to $280 as according to the income statement above reducing the air fare allows Westcoast Air to reduce the Net Loss by 9% and provides a higher contribution margin from passengers. However, Westcoast Air needs to make sure constantly that the number of passengers per flight will increase as projected or else the lower fare may increase the loss further (Drury, 2007).

Requirement # 3

Payment by travel international: 75000.0

Less Fixed Cost

Fixed annual lease costs allocated to each flight: (53,000)

Fixed ground services (maintenance, check in, baggage handling) costs allocated to each flight: (7,500)

Fixed flight crew salaries allocated to each flight: (7,000)

(67500.0)

Net Profit per flight: 7500.0

Note

It is unspecified if there is any travel agent involved in requirement # 3  hence no agent commission has been considered.

Summary:

On financial grounds, it seems favorable for Westcoast Air to accept the offer of Travel International as the difference in profit is substantial. However, there are other qualitative factors that Westcoast Air should take into account before making this decision (Charles et al., 2010):

1. Westcoast Air needs to gauge the opportunity-cost of this arrangement, i.e. will it be able to get more money by starting out on a new route (with a higher base) and more trips (to secure economies to scale), instead of giving the slot out to Travel International, and vice versa.
2. If the quality of food provided by the Travel International is not up to standards with Westcoast Air, the brand value of Westcoast Air will fall, as customers are not concerned with who has chartered and who is flying the aircraft, they associate general experience with brand value.
3. It is not clear whether the Travel International is chartering for a specific set of customers (i.e. its own personal users) or the general public (as a new market strategy). This may influence the choice of indulgence and long term business outcomes of Westcoast Air. Travel International may want to cater to the general public, and may only be getting into this venture as the cost of entry into the air travel market otherwise is extremely high i.e. high barriers to entry due to high capital cost.
4. Also if Westcoast Air Charters to Travel International it means that they would not be able to have regular scheduled flights each week. This arrangement could cause inconvenience to some of its passengers.
5. If Travel International decides to use low-cost fuel to save cost it may hurt the long term performance of the aircraft engine.
6. Another factor to consider is the stability of the relationship between Westcoast Air and Travel International; if this is not a long-term arrangement, Westcoast Air might lose current market share. Hence, may not benefit from sustained charter revenues.

Bibliography:

Charles et al. (2010). Introduction to Management Accounting. Prentice Hall.

Drury, C. (2007). Management and Cost Accounting. London: Cengage Learning.