Pepe Jeans

1. Alternative #1: More Flexible Ordering System (10% Increase in Sales)

Current Sales = £200M

New Sales: £200M x 10% Increase = £220M

Current Annual Costs: £200M * 40% = £80M

Additional Annual Costs: £80M * 30% = £24M

New Annual Costs = £104M

Current Profit Before Taxes: £200M * 32% = £64M

New Profit Before Taxes: £220M * 32% = £70.4M

Implementing the more flexible ordering system would increase costs by £24M while only increasing profits before taxes by £6.4M. While the company wouldn't have to invest in additional equipment or renovation costs using this alternative (therefore there is no payback period), it still causes them to incur more expenses than revenue and doesn't appear to be the best option.

Alternative #2: Build Finishing Operation in the U.K.

Equipment Investment: £1M

Annual Operating Costs: £500K

Renovations: £300K

Current Annual Costs: £200M * 40% = £80M

New Inventory Valued at 6 Weeks Worth of Yearly Cost of Sales:

(6/52) * £80M = £9.23M

Inventory Carrying Costs are 30% of New Inventory Value:

£9.23M * 30% = £2.769M

Assuming Sales Still Increase by 10%, Profit Before Taxes will Still Increase by

£6.4M

Additional Annual Profit: §6.4M - £3.269 = £3.131M

Annual Cost of Operations: £2.769 + £500K = £3.269M

Payback Period = Cost of Project/Annual Cash Inflows

= £1.3M/£3.131M * 52 Weeks

= =21.59 Weeks

Because the company could recoup its investment in just less than 22 weeks and begin earning additional profit it should choose to go with alternative number two and invest in a finishing operation in the U.K.

2. Pepe should consider expanding its operations into other countries that could provide greater flexibility than the current sourcing agent in Hong Kong. Considering the current success of the business, it could also opt to continue using its existing business model. However, this would only be a short-term solution because Pepe will eventually have to provide its customers with more flexibility or risk losing their business.