Pepe Jeans

Financial Analysis

Retailers estimated that Pepe Company would increase its sales by about 10% by using a flexible
ordering system.

Now the current sales are £ 200,000,000. Hence 10% of £ 200,000,000 is £ 20,000,000. Thus a flexible
system would lead an increase in sales of £ 20,000,000. Profit before taxes (PBT) at the rate of 32%
would lead to an increase in in PBT of £ 6,400,000 (32% of £ 20,000,000).

Alternative 1:

Decrease in lead time would lead to an increase in costs by 30%.Currently the yearly cost of sales is 40%
of sales of £ 200,000,000 which is £ 80,000,000. If the cost goes up by 30% then it would amount to a
cost increase of £ 24,000,000 (30% of £ 80,000,000). In return for this increase in cost, the company
could make an appropriate increase of in PBT of £ 6,400,000. It would still mean an £ 17,600,000 (£
24,000,000- £ 6,400,000) additional burden on the company. The advantage of this alternative is that
the company does not have to make any initial investment but has to incur this additional burden every
year. Since no investment is made, no payback period is calculated.

Alternative 2:

Initial fixed cost for equipment £ 1,000,000

Renovations £ 300,000
Total (Fixed Investments) £ 1,300,000
Operations Cost £ 500,000
Lead time 6 weeks

Yearly costs of sales at 40% = 40% *£ 200,000,000 = £ 80,000,000

6/52 * £ 80,000,000 = £ 9,230,000

Inventory carrying costs = 30% * £ 9,230,000 = £ 2,769,000

Recurring Costs = Inventory carrying costs + operations costs = £ 2,769,000 + £ 500,000 = £ 3,269,000

Thus we get an increase in the yearly profits before taxes = £ 6,400,000 - £ 3,269,000 = £ 3,130,000.

Now since the fixed investments made by the company is £ 1,300,000. Hence the payback period = (£
1,300,000/ £ 3,130,000) * 52 = 21.6 weeks.

This is a preferred alternative and should be recommended to Pepe Company.

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 Pepe Jeans

Other Alternatives

The other alternative would be to continue with the current arrangement. It is excellent from the
financial point of view but vulnerable from a marketing point of view. If Pepe continues to insist that
retailers place orders six months in advance with no possibility of cancellation or amendment, it will be a
matter of time before retailers will turn to other manufactures for more flexibility. Another alternative is
that Pepe consider sourcing its jeans in some other country where there are more costs advantages and
greater flexibility. Finally Pepe can consider the scenario where the entire manufacturing is transferred
to the UK. The financial strength of the company will allow it and provide more flexibility and
responsiveness.

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