Question 1

Qwest Travel Agency specialises in flights between New York and London. It books passengers on Virgin Airlines at 800 per round-trip ticket. The agency expects to sell 550 tickets each month and to earn a target operating income of 6,500.

Existing commission structure

Until last month, Virgin paid Sarah (Managing Director) a commission of 12% of the ticket price paid by each passenger. This commission was Sarah's only source of income.

Revised commission structure

However, Virgin Airlines has just announced a revised payment schedule for all travel agents. It will now pay travel agents a 12% commission per ticket up to a maximum of 55. Any ticket costing more than 600 generates only a 55 commission, regardless of the ticket price.

Cost information

Sarah's fixed costs are 15,000 per month (for salaries, rent, and so on), and its variable costs are 20 per ticket purchased for a passenger. This 20 includes a 15 per ticket delivery fee paid to Federal Express. (To keep the analysis simple, we assume each round-trip ticket purchased is delivered in a separate package. Thus, the 15 delivery fee applies to each ticket).

Sarah has limited knowledge about the use of cost volume profit analysis in supporting management decisions. Furthermore, Sarah claims "That there is no such thing as a fixed cost. All costs can be 'unfixed' given sufficient time".

Under the existing commission structure and the revised commission structure, what is the margin of safety? Show your calculations. (10 marks)

Explain your results and discuss the impact of the change in the commission structure. (10 marks)

Comment on Sarah's statement. Do you agree? What is the implication of your answer for cost volume profit analysis? (10 marks)