CASE: F-163

DATE: 04/08/02

DOZIER INDUSTRIES
Richard Rothschild, the chief financial officer of Dozier Industries, returned to his office after his
meeting with two officers of Southeastern National Bank. He had requested the meeting in order to
discuss financial issues related to Dozier’s first major international sales contract, which had been
confirmed the previous day, February 2, 1994. Initially, Rothschild had contacted Robert Leigh, a vice
president at the bank, who had primary responsibilities for Dozier’s business with Southeastern
National. Leigh had in turn suggested that Jane Gunn of the bank’s international division be included in
the meeting since Leigh felt that he, himself, lacked the international expertise to answer all the
questions Rothschild might raise.

The meeting had focused on the exchange risk related to the new sales contract. Dozier’s bid of
£594,000 for the installation of 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 transferred by cable
£59,400 (i.e., 10 percent of the contract amount) as deposit on the contract, with the balance due at the
time 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 £534,600 on May 2, 1994.

HISTORY OF THE COMPANY

Dozier, Inc. had been established in 1963 by Charles L. Dozier, formerly a design engineer for a large
electronics firm. The company specialized in electronic security systems for small firms and
households. By 1966, Dozier had begun to concentrate on military sales and the company's growth
paralleled the growth of U.S. expenditures in Vietnam. As U.S. involvement in Vietnam and military
expenditures in general began to decrease, Dozier's military sales slumped and the company sought
increased business in the private sector. During the period of transition from being primarily a military
contractor to relying on private sales, Dozier experienced severe reductions in revenues and profits (see
Exhibit I). In 1985, the company showed a profit for the first time in three years, and management was
confident that the company had turned the corner. Business grew steadily after 1985 but by 1993 sales
(nearly all in the US) were again slowing. The company made modest use of debt and aimed to
maintain a conservative balance sheet (see Exhibit II).

Professor Bruce McKern updated this case from an earlier version prepared by Mark Eaker in 1976 (S-F-163) as the basis for class
discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 2002 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or request
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 Dozier Industries F-163 p. 2

By early 1993, military sales were only about 20 percent of Dozier’s total revenue. The Company’s
management believed that the best prospects for future growth were sales to companies in countries
that were experiencing terrorist activity. Therefore, in the spring of 1993 Dozier launched a marketing
effort overseas. The selling effort had not met with much success until the confirmation of the contract,
discussed above, with the U.K. manufacturing firm. The new sales contract, although large itself, had
the potential of being expanded in the future since the company involved as a large multinational firm
with manufacturing facilities in many countries. (See Exhibit III for bid preparation).

Foreign Exchange Risk and Hedging

On February 2, the day the bid was accepted, the value of the pound was $1.41. However, the pound
had been depreciating slightly for the past six months (see Exhibit IV). 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 receivable.

Jane Gunn, the international specialist, had explained that Rothschild had several options. 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.

Gunn explained that the 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 options
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 insure 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 May 2, 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.

Dozier considered 17% to be its weighted average cost of capital. Its cost of borrowing for working
capital needs was currently 13%. The business risk on the U.K. contract was fairly typical of other
projects in which Dozier was involved in the United States.

Leigh assured Rothschild that Southeastern National would be able to assist Dozier in implementing
whatever decision Rothschild made. Dozier had a $1.5 million line of credit with Southeastern
National. Jane Gunn indicated that there would be no difficulty for Southeastern to arrange the pound
loan for Dozier through its correspondent bank in London.
She felt that such a loan would be at 2 percent above the U.K. prime rate. In order to assist Rothschild
in making his decision, Gunn provided him with information on recent interest rates and the spot and
forward exchange rates (see Exhibit V).

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 Dozier Industries F-163 p. 3

Rothschild was aware that in preparing the bid, Dozier had allowed for a profit margin of only 6
percent in order to increase the likelihood of winning the bid and hence developing an important
foreign contact. The bid was submitted on December 16, 1993. 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 16, since the U.K. customer had stipulated payment in pounds.

In figuring the costs on this particular contract, Dozier had assumed that virtually all components and
technical expertise would need to be sourced in the United States. However, Dozier hoped that if a
foothold were gained in the United Kingdom, some of the direct costs on future contracts would be
sourced there, as Dozier became acquainted with local suppliers.

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 1994 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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 Dozier Industries F-163 p. 4

Exhibit 1
Dozier, Inc.
Sales and Income Summary (1981-1993)

Year Ended Sales Net Income

31 December ($000) ($000)

1981 2,314 128

1982 2,397 134
1993 1,521 (43)
1984 1,918 (86)
1985 2,127 179
1986 3,858 406
1987 4,576 487
1988 4,680 402
1989 5,100 457
1990 5,300 409
1991 5,471 503
1992 5,986 522
1993 6,427 560

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 Dozier Industries F-163 p. 5

Exhibit 2
Dozier, Inc.
Balance Sheet as of December 31, 1993

Assets

Current Assets:
Cash and Securities 147,286
Accounts Receivable 859,747
Inventories 1,113,533
Total Current Assets 2,120,566

Properties, Plants, and Equipment:

At Cost 4,214,906
Less: Accumulated Depreciation 1,316,702
Net Plant: 2,898,204

Other Assets:
Investments and Loans 225,000

Total Assets 5,243,770

Liabilities and Equities

Current Liabilities:
Accounts Payable 467,291
Notes Payable - Bank 326,400
Total Current Liabilities 793,691

Long-Term Liabilities:
Notes Payable 275,000

Common Equity
Common Stock 1,126,705
Reserves 313,622
Retained Earnings 2,734,752
Total Equity 4,175,079

Total Liabilities and Equity 5,243,770

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 Dozier Industries F-163 p. 6

Exhibit 3
Dozier, Inc.
Bid Preparation

Materials $414,250
Direct labor 208,410
Shipping 35,000
Direct overhead* 104,205
Allocation of indirect overhead 50,246
Total Cost 812,111
Profit Factor 49,189
Total $861, 300

Spot pound rate on December 16: 1.4500

Pound value of the bid: £594,000

* Based on 50% of direct labor.

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 Dozier Industries F-163 p. 7

Exhibit 4
Dozier, Inc.
Historical Spot and Forward Pound Rates in U.S. Dollars

Spot 3-Month Forward

7/29/93 1.5208 1.5228

8/5/93 1.4825 1.4854
8/12/93 1.4798 1.4827
8/19/93 1.5192 1.5216
8/26/93 1.5030 1.5047
9/2/93 1.4948 1.4973
9/9/93 1.4955 1.4972
9/16/93 1.4993 1.5011
9/23/93 1.5000 1.5012
9/30/93 1.4960 1.4968
10/7/93 1.5012 1.5025
10/14/93 1.5017 1.5031
10/21/93 1.5020 1.5037
10/28/93 1.4950 1.4970
11/4/93 1.4860 1.4890
11/11/93 1.4860 1.4889
11/18/93 1.4770 1.4799
11/25/93 1.4600 1.4625
12/2/93 1.4585 1.4610
12/9/93 1.4363 1.4396
12/16/93 1.4500 1.4620
12/23/93 1.4293 1.4331
12/30/93 1.4505 1.4534
1/6/94 1.4085 1.4110
1/13/94 1.4008 1.4024
1/20/94 1.4115 1.4169
1/27/94 1.4270 1.4288
2/3/94 1.4100 1.4118

Source: Harris Bank Weekly Review.

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 Dozier Industries F-163 p. 8

Exhibit 5
Dozier, Inc.
Interest and Exchange Rate Comparisons
February 3, 1994

United United
States Kingdom

Three month money* 9.50 9.00

Prime Lending Rate 11.00 10.00
Three month deposits (large amounts) 9.5625 9.3125
Euro $ 3 month 9.8750
Euro £ 3 month (Paris) 9.3125

Other key London rates:

91-day treasury bills 8.9

7-day Interbank 9.1

Spot rate for the pound: 1.4100

Three-month forward pound: 1.4118

* Prime commercial paper in the United States; interbank rates in the United Kingdom.

Source: The Economist

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