Caselet: TransWestern Airlines- Cost-Volume-Profit Analysis, Pricing
and Break-even Analysis in the Airline Industry
Trans Western Airlines is considering a proposal to initiate air service
between Phoenix, Arizona, and Las Vegas, Nevada. The route would be
designed primarily to serve the recreation and tourist travelers who 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 A.M. to 6 P.M. on Mondays through Fridays. The fare price schedule, or tariff,
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 $100 one way during business hours and a
fare of $60 for all other hours would equalize the passenger load during
business-travel and tourist-travel hours.
To operate the route, the airline would need two 200-passenger jet aircraft.
The air-craft would be leased at an annual cost of $10,000,000 each. Other
committed costs for ground service would amount to $5,000,000 per year.
Operation of each aircraft requires a flight crew whose salaries are based
primarily on the hours of flying time. The costs of the flight crew are
approximately $800 per hour of flying time.
Fuel costs are also a function of flying time. These costs are estimated at
$1,000 per hour of flying time. Flying time between Phoenix and Las Vegas is
estimated at 45 minutes each way.
The flexible costs associated with processing each passenger amount to $5.
This amount includes ticket processing, agent commissions, and baggage
handling. Food and beverage service cost $10 per passenger and will be
offered at no charge on flights during business hours. The airline expects to
recover the cost of this service on non-business-hour flights through charges
levied for alcoholic beverages.
Assignment Questions
1) If six business flights and four tourist flights are offered each way every
weekday, and 12 tourist flights are offered each way every Saturday and
Sunday, what is the average number of passengers that must be carried on
each flight to break even?
2) What is the breakeven load factor (percentage of available seats occupied)
on a route?
3) If Trans Western Airlines operates the Phoenix – Las Vegas route, its
aircraft on that route will be idle between midnight and 6 A.M. The airline is
considering offering a “Red Die” special, which would leave Phoenix daily at
midnight and return by 6 A.M. The marketing division estimates that if the
fare were no more than $40, the load factor would be 50% for each Red Die
flight. Operating costs would be the same for this flight, but advertising costs
of $10,000 per week would be required for promotion of the service. No food
or beverage costs would be borne by the company. Management wants to
know the minimum fare that would be required to break even on the Red Die
special, assuming that the marketing division’s passenger estimates are
correct.
Transwestern Airlines
Business Fare per passenger 100
Tourist Fare 60
Fixed Annual Cost Per annum
Lease cost 20000000
Service Cost 5000000
Total 25000000
Per week 480769
Less
Flexible Cost
Flight crew cost/hour 800
Fuel Cost/Hour 1000
Total/ Hour 1800
Total/ flight of 45 minutes 1350
Processing Cost/ Passenger 5
Food & Beverage/ Passenger 10
Business Tourist
Total variable cost / Passanger 15 5
=
1)
No. of flights in a week
Business Flights 1)
6*5 30
Tourist Flights 2)
4*5 20
2*12 24 3)
44
Yearly flights
52 weeks in a year
Business flight 3120
Tourist fligh 4576
Total Flights 7696
Per flight fixed annual cost propor 3248
Flight wise distribution of fixed cost
Flights Business Tourist Total
Weekdays 6*5*2 4*5*2
Weekends 0 12*2
Total 60 88
Passanger capacity
Business 200 200
Tourist
Business Tourist
Fare 100 60
Variable Cost 15 5
Contribution 85 55
Fixed cost
Fixed Annual Cost distribution/Week 194906 285863 480769
Flexible Cost/week 81000 118800 199800
Total 275906 404663 680569
Break Even Formula
Fixed Cost 275906 404663
=
Contribution per unit 85*60 55*88
Break even Passangers/flight 54 84
Load Factor 27% 42%
Red Eye Special
No. of Flights 28
Fare/ Passanger 40
Load Factor per flight 50%
Occupancy per flight 100
Per passanger Per flight Per week
Operating Cost
Flight operating flexible cost/flight 1350 37800
Advertising Cost 10000
17 1707 47800
Variable Cost 5
Total Cost 22
Profit 18
Fare/ Passanger 40
A contribution margin of 22 is required to breakeven at occupancy of 100 per flight
Hence, fare = Contribution per passenger + VC per passenger
minimum Fare 22
