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Relevant and Irrelevant costs

Dear Managing Director,

Referred to your memo concerning the business proposition, I am agreeable to your idea in considering buying an aircraft and employing a full time pilot for Clearday.

For your knowledge, the types of costs incurred consist of relevant and irrelevant cost. Relevant costs include initial cost, consequence cost, incremental cost and opportunity cost. Irrelevant costs include historical cost and sunk cost. Please refer to table 1 for the type of relevant and irrelevant costs for Clearday. As part of decision making, I suggest that you should consider using relevant costing approach therefore you will need to take note of the other relevant costs as per stated on Table 2.

Table 1

Secondhand Cessna

Initial Cost

Relevant Cost

Hangarage

Consequence Cost

Relevant Cost

Maintenance and repairs

Consequence Cost

Relevant Cost

Landing and handling fees

Incremental Cost

Relevant Cost

Pilot’s salary

Avoidable Cost

Relevant Cost

Salary on cost

Avoidable Cost

Relevant Cost

Fuel

Incremental Cost

Relevant Cost

Insurance and certification

Consequence Cost

Relevant Cost

Table 2

Depreciation

Sunk Cost

Irrelevant Cost

500 spare hours for the pilot

Opportunity Cost

Relevant Cost

Proceed from sales of Cessna

Opportunity Cost

Relevant Cost

Revenue for renting to Flying club

Opportunity Cost

Relevant Cost

Type of costs stated on table 2 as per stated above are based on my assumption.

Assuming the total number of a pilot’s working hours per annum is 1700 hours. This make up of 400 flying hours, 800 hours on other duties like flight planning and aircraft maintenance, and 500 spare hours. Based on your possibility, the pilot’s spare time can be used to cover general office work or driving, which means you can save some opportunity cost of £10,588.00. See appendix 1.

Assuming that you are able to rent the aircraft to the local flying club at £105 per hours and the flying hours is at least 120 hours per annum. Clearday will bear all the costs except the landing fees. With this extra flying, Clearday will only have 20% increased on maintenance and repairs and insurance and certification. This opportunity revenue for renting the aircraft to a local flying club is £5,940.00.See appendix 2.

Appendix 3 shows the comparison between the cost incurred for buying and renting the aircraft based on your data that Clearday’s usual flying hours is 400 hours per annum. As mentioned above, for decision making, you should not consider irrelevant cost. Therefore the cost for buying the aircraft is £86,372.00 while renting is £55,600.00. Looking at the comparison on appendix 3, it shows that buying is not very possible with only 400 flying hours. If you have notice, the cost differences between buying and renting is not too big therefore I suggest that you should consider to increase the number of flying hours since the pilot have a spare hours of 500 hours per annum.

Appendix 4 and appendix 5 show the comparisons for different number of flying hours, 900 and 1100 flying hours respectively. The comparison result shows that the there will be a saving of £5,440.00 if Clearday consider to buy an aircraft and employing a full time pilot but fly 1100 flying hours per annum. Considering the fact that the total working hours for a pilot is 1700 hours per annum, therefore in order to meet the 1100 flying hours, the pilot will also need to reduce the number of hours spend on planning maintaining the aircraft from 800 hours to 600 hours per annum.

Since the outcome result shows positive, therefore I support your idea of buying the aircraft and employing a full time pilot. I hope that the above report has provided you a good detail costing which can help you.

Yours Sincerely,

Student

Appendix 1

Assuming total number of pilot's work hours is 1700 hours per annum

800 (for planning and maintenance)

800

400 (flying hours)

400

500 (spare hour)

500

Pilot's salary (per annum)

£36,000.00

Rate/per hour

£21.18

Opportunity saving on spare hours

£10,588.00

Appendix 2

Note 1: As per stated on the memo, landing fee will be bear by Flying club. Assuming, Flying club will paid to Clearday instead to Plummet Aviation.

Rental revenue from Flying club

£12,600.00

Landing fee bear by Flying club (Note 1)

£1,800.00

Less Expense bear by Clearday

Fuel cost incurred

£6,480.00

Maintenance and repair

£1,080.00

Insurance and certification

£900.00

Balance revenue after deducting cost

£5,940.00

Appendix 3

Note 2: As per appendix 2, Flying club will pay Clearday for the landing fee incurred. Clearday will therefore need to pay Plummet Aviation.

Buy @ 400 flying hours

Irrelevant Cost

Depreciation

£3,600.00

Total Irrelevant Cost

£3,600.00

Relevant Cost

Cost for secondhand Cessna

£ 36,000.00

Proceed after Cessna is sold

(£18,000.00)

Hangarage

£3,900.00

Maintenance and repair

£5,400.00

Insurance and certification

£4,500.00

Pilot's Salary

£36,000.00

Salary on cost

£5,700.00

Fuel

£ 21,600.00

Landing and handling fees (for 400 hours)

£6,000.00

Landing and handling fees (for Flying club) Note 2

£1,800.00

Revenue earned from Flying club

(£5,940.00)

Amount save for using pilot's time on other general work

(£10,588.00)

Total relevant Cost

£86,372.00

Total Cost - Irrelevant and Relevant (Buy)

£89,972.00

Rent @ 400 flying hours

Rental

£28,000.00

Fuel

£21,600.00

Landing and handling fees

£6,000.00

Total Cost (Rent)

£55,600.00

Appendix 4

Buy @ 900 flying hours

Relevant Cost

Cost for secondhand Cessna

£36,000.00

Proceed after Cessna is sold

(£18,000.00)

Hangarage

£3,900.00

Maintenance and repair

£12,150.00

Insurance and certification

£10,125.00

Pilot's Salary

£36,000.00

Salary on cost

£5,700.00

Fuel

£48,600.00

Landing and handling fees

£13,500.00

Landing and handling fees (for Flying club) Note 2

£1,800.00

Revenue earned from Flying club

(£5,940.00)

Total relevant Cost

£143,835.00

Rent @ 900 flying hours

Rental

£63,000.00

Fuel

£48,600.00

Landing and handling fees

£13,500.00

Total Cost (Rent)

£125,100.00

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