Question

MidCoast Airlines provides charter airplane services. In October of this year, the company is operating at 60% of its capacity when it receives a bid from the local community college. The college is organizing a Washington, D.C., trip for its international student group. The college budgeted only \(30,000 for roundtrip airfare. MidCoast Airlines normally charges between \)50,000 and \(60,000 for such service. MidCoast determines its cost for the round-trip flight to Washington to be \)44,000, which consists of the following:

Variable cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \(15,000

Fixed cost (allocated). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29,000

Total cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \)44,000

Although the manager at MidCoast supports the college’s educational efforts, she cannot justify accepting the \(30,000 bid for the trip given the projected \)14,000 loss. Still, she decides to consult with you, an independent financial consultant. Do you believe the airline should accept the bid from the college? Prepare a memorandum, with supporting computations, explaining why or why not.

Short answer

Yes the bid should be accepted as it will increase the revenue by $15,000. If the bid will be accepted it will increase the income of the airline by $15,000. There will be no increase in fixed cost and hence fixed cost will be irrelevant in making the decision.

Step-by-step solution

Computation of contribution margin

$\begin{array}{c}\mathbf{Contributionmargin}\mathbf{=}\mathbf{Revenue}\mathbf{-}\mathbf{Variablecost}\\ \mathbf{=}\mathbf{\$}\mathbf{30}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{000}\\ \mathbf{=}\mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{000}\end{array}$

Analysis

By accepting the college's bid, the airline will raise its revenue by $15,000 because the college trip will contribute a margin of $15,000 to the bid.

Accepting the college proposal will result in no increase in fixed costs, rendering fixed costs irrelevant to the decision-making process.