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DOZIER INDUSTRIES (A)

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Richard Rothschild, the chief financial officer of Dozier Industries, returned to his office
after meeting with two officers of Southeastern National Bank. He had requested the meeting to
discuss financial issues related to Dozier’s 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 Dozier’s business with Southeastern

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National. Leigh, feeling that he lacked the international expertise to answer all the questions
Rothschild might raise, had suggested that John Gunn of the bank’s International Division be
included.

The meeting had focused on the exchange risk related to the new sales contract. Dozier’s bid
of (British pounds) GBP1.175 million to install an internal security system for a large manufacturing
firm in the United Kingdom had been accepted. In accordance with the contract, the British firm had
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transferred a 10% deposit (GBP117,500), the balance due when the system was completed. Dozier’s
production vice president, Mike Miles, had assured Rothschild that there would be no difficulty in
completing the project within the 90-day period stipulated in the bid. As a result, Rothschild was
planning on receiving GBP1.0575 million on April 14, 1986.
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Company History

Dozier 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 management. Dozier had formerly been a design
engineer for a large electronics firm. In 1973 he began his own company to market security systems
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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 design systems for small private firms and households. Dozier’s inexperience 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 was
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This 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
[email protected] 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 means—electronic, mechanical, photocopying, recording, or
otherwise—without the permission of the Darden School Foundation.

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confident that the company had turned the corner. Exhibit 2 contains the balance sheet at the end of
1985.

The company’s management believed that sales to foreign corporations represented good
prospects for future growth. Consequently, in the spring of 1985, Dozier had launched a marketing

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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 involved was a large multinational firm with
manufacturing facilities in many countries.

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Foreign Exchange Risk and Hedging

On January 13, the day the bid was accepted, the value 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 next 90 days,
and it was this worry that prompted his discussion at the bank. He wanted to find out what
techniques were available to Dozier to reduce the exchange risk created by the outstanding pound
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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 choose to hedge his exchange risk.
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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 spot 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
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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.
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Leigh assured Rothschild that Southeastern National would be able to assist 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
arrange 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 assist Rothschild in making his

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decision, Gunn provided him with information 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

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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.

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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 transactions 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.
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Exhibit 1
DOZIER INDUSTRIES (A)
Sales and Income Summary

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Year Ended December 31 Sales (in thousands) Net Income (in thousands)
1973 456 41
1974 631 54
1975 890 73
1976 1,610 151

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1977 3,860 324
1978 7,242 760
1979 11,338 1,162
1980 15,138 1,488
1981 20,371 1,925
1982 21,455 712
1983 22,501 (242)
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1984 23,986 (36)
1985 25,462 309
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Exhibit 2
DOZIER INDUSTRIES (A)
Balance Sheet as of December 31, 1985

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Assets
Current assets:
Cash and securities USD294,572
Accounts receivable 1,719,494
Inventories 2,227,066
Total current assets 4,241,132

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Properties, plants, and equipment:
At cost 8,429,812
Less: Accumulated depreciation 2,633,404
Net plant 5,796,408
Other assets:
Investments and loans 450,000
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Total assets USD10,487,540

Liabilities and Equity

Current liabilities:
Accounts payable 934,582
Notes payable - bank 652,800
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Total current liabilities 1,587,382

Long-term liabilities:
Notes payable 550,000
Common equity:
Common stock 2,253,410
Reserves 627,244
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Retained earnings 5,469,504

Total equity 8,350,158
Total liabilities and equity USD10,487,540
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Exhibit 3
DOZIER INDUSTRIES (A)
Bid Preparation

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Materials USD847,061
Direct labor 416,820
Shipping 70,000
Direct overhead* 208,410

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Allocation of indirect overhead 100,492
Total cost 1,642,783
Profit factor USD98,567
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Spot pound rate on December 3: USD1.4820
Pound value of the bid: GBP1,175,000
*
Based on 50% of direct labor.
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No
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Exhibit 4
DOZIER INDUSTRIES (A)
Interest and Exchange Rate Comparisons
January 14, 1986

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United States United Kingdom
Three-month money* 7.65 13.41
Prime lending rate 9.50 13.50
Three-month deposits (large amounts) 8.00 12.90
EUR/USD 3-month (LIBOR) 8.3

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EUR/USD 3-month (Paris) 13.2
3-month treasury bills in London 12.2

The spot rate for the pound: USD1.4370

Three-month forward pound: USD1.4198
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*
Prime commercial paper in the United States; Interbank rates in the United Kingdom.

Source: The Economist.

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No
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Exhibit 5
DOZIER INDUSTRIES (A)
Historical Spot and Forward Pound Rates in U.S. Dollars

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Spot 3-Month Forward Rate
7/9/85 1.3640 1.3490
7/16 1.3880 1.3744
7/23 1.4090 1.3963
7/30 1.4170 1.4067
8/6 1.3405 1.3296

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8/13 1.3940 1.3828
8/20 1.3900 1.3784
8/27 1.3940 1.3817
9/4 1.3665 1.3553
9/10 1.3065 1.2960
9/17 1.3330 1.3226
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9/24 1.4200 1.4089
10/1 1.4120 1.4005
10/8 1.4155 1.4039
10/15 1.4120 1.4007
10/22 1.4290 1.4171
10/29 1.4390 1.4270
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11/5 1.4315 1.4194

11/12 1.4158 1.4037
11/19 1.4320 1.4200
11/26 1.4750 1.4628
12/3 1.4820 1.4704
12/10 1.4338 1.4214
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12/17 1.4380 1.4249

12/23 1.4245 1.4114
12/30 1.4390 1.4260
1/7/86 1.4420 1.4284
1/14/86 1.4370 1.4198

Source: Chicago Mercantile Exchange Statistical Yearbook.

Do

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