Costing in Pepe Denim Kesar Bajaj (Bajaj), chairman of Pepe Denim, a manufacturer and retailer of jeans in India, was facing tremendous pressure to improve the financial position of the company and its market valuation. Bajaj and his younger brother Dinkar had floated Pepe Denim as a private limited company in Ahmedabad, Gujarat, in 1984. In 1994, the brothers decided to convert the company into a public limited company. Pepe Denim began manufacturing operations with just one factory in Ahmedabad district but the brothers put in a lot of hard work and took the company to a level where in 2011, it had 300 stores spread throughout the country and a workforce of 20,000. It also used to export its jeans to China, Brazil, and Nepal Till 2007, the company did very good business with its sales increasing every year. It earned exceptional growth in valuation resulting from an increase in the company's stock prices. After 2007, however, the stock prices of the company started to decline even though sales continued to be consistent. Though there was no decrease in sales, the profits began to fall. The brothers thought that the decline in the stock prices and profits was due to the economic slowdown and recession. Since there was consistency in sales, they concluded that the profits were declining because of the increase in costs due to inflation. But the stock prices of the company remained flat and profits continued to decline even after 2010 when the economy had started reviving, stock indices had started rising, and the stock prices of other companies had also started soaring The shareholders of the company raised concerns over the declining profits of the company. As a result of a heated shareholders' meeting, Bajaj came under pressure to improve the company's financial position and its market valuation. In order to understand the present status of production, costs, sales, and the future prospects of the company's product in the market, he immediately called Vipin, the company's cost accountant, and Sneha, the marketing manager. Vipin furnished the following cost information (Refer to Exhibit I) for the year ending March 31, 2010, and the changes in costs which were expected in the coming year: Exhibit - I Production and Sales- 1500000 units (in 000s) Sales-1500000 Direct Wages- 270000 Direct Materials- 330000 Factory Overheads- 325000 Administration overheads-205000 Sales overheads-90000 On account of intense competition, the following changes were estimated in the subsequent year: 1. N Production and sales activity would be increased by one third. Material rate would be lowered by 25%. However, there would be a 20% increase in consumption which would take care of the increase in production level. 3. Direct wages cost would be reduced by 20% due to automation. 4. Out of the above factory overheads (given in Exhibit I), Rs. 45000 were fixed in nature. The remaining factory expenses would be variable in proportion to the number of units produced. 5. Total administration expenses would be lowered by 40%. 6. Sales overhead per unit would remain the same. On the basis of cost and profit estimation for the years ending March 31, 2010, and March 31, 2011, Vipin told Bajaj that 6 % decline in profit on sales was expected in 2011. Bajaj realized from Vipin's report that the reason for the decline in profits despite the consistent increase in sales volume was the heightening competition from other brands in the market. Since Sneha was in direct contact with the market, Bajaj asked her to carefully analyze the potential of the company's product in the market and suggest the options available to overcome the problem. He gave Sneha 10 days' time to do this. After 10 days, Sneha reported back to Bajaj. In order to carry out a formal analysis of the options available with regard to business opportunities, Bajaj immediately called a meeting with the board of directors and asked Vipin and Sneha to be present