Question

WSM Corporation is considering offering an air shuttle service between Sao Paulo and Rio de Janeiro. It plans to offer four flights every day (excluding certain holidays) for a total of 1,400 flights per year (= 350 days × 4 flights per day). WSM has hired a consultant to determine activity-based costs for this operation. The consultant’s report shows the following.
Activity Activity Measure (cost driver) Unit Cost(cost per unit of activity)
Flying and maintaining aircraft Number of flights $ 500 per flight
Serving passengers Number of passengers $ 5 per passenger
Advertising and marketing Number of promotions $ 40,000 per promotion


WSM estimates the following annual information. With 4 advertising promotions, it will be able to generate demand for 40 passengers per flight at a fare of $150. The lease of the 60-seat aircraft will cost $2,000,000. Other equipment costs will be $1,000,000. Administrative and other marketing costs will be $600,000.



Required:

a. What annual operating income can WSM expect from this new service?

b-1. WSM is considering selling tickets over the Internet to save on commissions and other costs. It is estimated that the cost driver rate for flights would decrease by $100 as a result of Internet sales. Administrative and other marketing costs would increase by $1 million. WSM estimates that the added convenience would generate a 5 percent increase in demand. All other costs and fares would remain the same. What annual operating income can WSM expect from adopting Internet ticket sales?

b-2. Would you recommend that WSM adopt Internet ticket sales?

c. Assume that WSM management decides not to adopt the Internet strategy, regardless of your answer to requirement (b). Instead, it is now considering a plan to sell tickets at two prices. An unrestricted ticket (good for travel at any time on any day) would sell for $ 175. A discount ticket, good for reservations made in advance, would sell for $130. Management estimates that it can sell 35,000 tickets (25 per flight) at the unrestricted airfare of $175. All other data remain the same.

Ignoring the information in requirement (b), how many discounted tickets would WSM have to sell annually to earn an operating income of $3,700,000? Assume that the annual number of flights remains at 1,400 and that the discounted tickets would be evenly divided across the 1,400 flights.

Answer 1

The annual operating income that WSM can expect from this new service is $1686000.

How to calculate the income?

Sales revenue = 40 × 1400 × $225 = $12600000

Less: Cost

Flight related = 1400 × $1600 = $2240000

Passengers related = 40 × 1400 × $4 = $224000

Advertisement = 20 × 60000 = $1200000

Operating income = $1686000

The annual operating income that WSM can expect from this new service is $1686000

b1. Sales revenue = 42 × 1400 × $225 = $13230000

Less: Cost

Flight related = 1400 × $1500 = $2100000

Passengers related = 42 × 1400 × $4 = $235200

Advertisement = 20 × 60000 = $1200000

Operating income = $9694800

b2. I'll not recommend the company to adopt internal slaves ticket because the operating income is less.

c. Let the number of discount tickets be x.

Operating income = 1,700,000

Total revenue = (35000 × 250) + (x × 150)

= 875000 + 150x

The total cost is 10690000 + 140000 + 4x

This will then be:

8750000 + 150x - 10690000 + 140000 + 4x = 1700000

x = 25890 tickets.

Learn more about operating income on:

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