Pepe Jeans Case
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.
Other Alternatives
The other alternative would be to continue with the current arrangement. It is
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.
Other Alternatives
The other alternative would be to continue with the current arrangement. It is