DOZIER industri Essay

Richard Rothschild, the chief financial officer of Dozier Industries, returned to his office after coming upon with two officers of Southeastern National Bank. He had requested the meeting to discuss financial issues related to Doziers first major international sales contract, which had been confirmed the previous day, January 13, 1986. Initially, Rothschild had contacted Robert Leigh, a vice president of the bank, who had primary responsibilities for Doziers business with Southeastern National. Leigh, feeling that he lacked the international expertise to answer all the questions Rothschild might raise, had suggested that John Gunn of the banks International Division be included.The meeting had focused on the throw risk related to the new sales contract. Doziers squall of (British dog mystifys) GBP1.175 million to install an internal security formation for a large manufacturing firm in the fall in Kingdom had been accepted. In accordance with the contract, the British firm had transferred a 10% deposit (GBP117,500), the balance imputable when the system was completed. Doziers production vice president, Mike Miles, had assured Rothschild that there would be no difficulty in completing the project within the 90-day boundary stipulated in the bid. As a result, Rothschild was planning on receiving GBP1.0575 million on April 14, 1986.Comp each HistoryDozier Industries, a relatively young firm specializing in electronic security systems, was established in 1973 by Charles L. Dozier, who was still president and the owner of 78% of the stock. The remaining 22% was held by other members of focussing. Dozier had formerly been a trope engineer for a large electronics firm. In 1973 he began his own conjunction to market security systems and began by concentrating on military sales. The company experienced rapid growth for almost a decade. But in 1982, as Dozier faced increased competition in this market, management attempted to branch out to foundation systems for small private firms and households. Doziersinexperience in this market, combined with poor planning efforts, slowed sales growth and led to a severe reduction in profits (see Exhibit 1). The company shifted its focus to larger corporations and met with better success. In 1985, the company showed a profit for the first time in three years, and management wasThis case was prepared by Professor Mark R. Eaker. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 1986 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to salesdardenbusinesspublishing.com No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of the Darden School Foundation. confident that the company had turned the corner. Exhibit 2 contains the balance sheet at the end of 1985.The companys management believed that sales to foreign corporations represented good prospects for future growth. Consequently, in the spring of 1985, Dozier had launched a marketing effort overseas. The selling effort had not met with much success until the confirmation of the contract discussed previously. The new sales contract, although large in itself, had the potential of being expanded in the future because the company twisting was a large multinational firm with manufacturing facilities in many countries.Foreign Exchange Risk and HedgingOn January 13, the day the bid was accepted, the appraise of the pound was (U.S. dollars) USD1.4480. But the pound had weakened over the previous six weeks(see Exhibit 5). Rothschild was concerned that the value of the pound might depreciate even further during the neighboring 90 long time, and it was this worry that prompted his disc ussion at the bank. He wanted to find out what techniques were available to Dozier to reduce the exchange risk created by the outstanding pound receivable.Gunn, the international specialist, had explained that Rothschild had several alternatives. First, of course, he could do nothing. This would leave Dozier vulnerable to pound fluctuations, which would entail losses if the pound depreciated, or gains if it appreciated versus the dollar. On the other hand, Rothschild could admit to hedge his exchange risk. Gunn explained that a hedge involved taking a position opposite to the one that was creating the foreign exchange exposure. This could be accomplished either by engaging in a forward contract or via a taint transaction. Since Dozier had an outstanding pound receivable, the appropriate hedging transactions would be to sell pounds forward 90 days or to secure a 90-day pound loan. By selling pounds forward, Dozier would incur an obligation to deliver pounds 90 days from now at the rate established today. This would ensure that Dozier would receive a set dollar value for its pound receivable, regardless of the spot rate that existed in the future. The spot hedge worked similarly in that it also created a pound obligation 90 days hence.Dozier would borrow pounds and exchange the proceeds into dollars at the spot rate. On April 13, Dozier would use its pound receipts to repay the loan. Any gains or losses on the receivable due to a change in the value of the pound would be offset by equivalent losses or gains on the loan payment. Leigh assured Rothschild that Southeastern National would be able to dish Dozier in implementing whatever decision Rothschild made. Dozier had a USD3 million line of credit with Southeastern National. John Gunn indicated that there would be no difficulty for Southeastern to erect the pound loan for Dozier through its correspondent bank in London. He believed that such a loan would be at 1.5% above the U.K. prime rate. In order to assi st Rothschild in making hisdecision, Gunn provided him with education on interest rates, spot and forward exchange rates, as well as historical and forecasted information on the pound (see Exhibits 4, 5, and 6). Rothschild was aware that in preparing the bid, Dozier had allowed for a profit margin of only 6% in order to increase the likelihood of winning the bid and, hence, developing an important foreign contact. The bid was submitted on December 3, 1985. In arriving at the bid, the company had estimated the cost of the project, added an amount as profit, but kept in mind the highest bid that could conceivably win the contract. The calculations were made in dollars and then converted to pounds at the spot rate existing on December 3 (see Exhibit 3), since the U.K. company had stipulated payment in pounds.Rothschild realized that the amount involved in the contract was such that an adverse move in the pound exchange rate could put Dozier in a loss position for 1986 if the transacti ons were left unhedged. On the other hand, he also became aware of the fact that hedging had its own costs. Still, a decision had to be made. He knew that no action implied that an unhedged position was the best alternative for the company.Exhibit 1DOZIER INDUSTRIES (A)Sales and Income Summary course of instruction Ended December 311973197419751976197719781979198019811982198319841985Sales (in thousands)4566318901,6103,8607,24211,33815,13820,37121,45522,50123,98625,462Net Income (in thousands)4154731513247601,1621,4881,925712(242)(36)309Exhibit 2DOZIER INDUSTRIES (A)Balance Sheet as of December 31, 1985Assets flow rate assetsCash and securitiesAccounts receivableInventories impart current assetsProperties, plants, and equipmentAt costLess Accumulated depreciationNet plantOther assetsInvestments and loansTotal assetsLiabilities and Equity rate of flow liabilitiesAccounts payableNotes payable bankTotal current liabilitiesLong-term liabilitiesNotes payableCommon equityCommon stockReser vesRetained earningsTotal equityTotal liabilities and equityUSD294,5721,719,4942,227,0664,241,1328,429,8122,633,4045,796,408450,000USD10,487,540934,582652,8001,587,382550,0002,253,410627,2445,469,5048,350,158USD10,487,540Exhibit 3DOZIER INDUSTRIES (A)Bid PreparationMaterialsDirect laborShippingUSD847,061416,82070,000Direct operating expense*208,410Allocation of indirect overhead100,492Total costProfit factor1,642,783USD98,567Spot pound rate on December 3 USD1.4820Pound value of the bid GBP1,175,000*Based on 50% of direct labor.Exhibit 4DOZIER INDUSTRIES (A)Interest and Exchange Rate ComparisonsJanuary 14, 1986Three-month money*Prime lending rateThree-month deposits (large amounts)EUR/USD 3-month (LIBOR)EUR/USD 3-month (Paris)3-month treasury bills in London get together States United Kingdom7.6513.419.5013.508.0012.908.313.212.2The spot rate for the pound USD1.4370Three-month forward pound USD1.4198*Prime commercial paper in the United States Interbank rates in the United Kingdom.S ource The Economist.Exhibit 5DOZIER INDUSTRIES (A)Historical Spot and earlier Pound Rates in U.S. Dollars7/9/857/167/237/308/68/138/208/279/49/109/179/2410/110/810/1510/2210/2911/511/1211/1911/2612/312/1012/1712/2312/301/7/861/14/86Spot1.36401.38801.40901.41701.34051.39401.39001.39401.36651.30651.33301.42001.41201.41551.41201.42901.43901.43151.41581.43201.47501.48201.43381.43801.42451.43901.44201.4370Source Chicago Mercantile Exchange Statistical Yearbook.3-Month Forward Rate1.34901.37441.39631.40671.32961.38281.37841.38171.35531.29601.32261.40891.40051.40391.40071.41711.42701.41941.40371.42001.46281.47041.42141.42491.41141.42601.42841.4198