Dozier Industries (a) Case Report

Dozier Industries (A) Case Report

To minimize Dozier Industries’ exposure to foreign currency exchange losses, we recommend that the firm enact a forward contract to guarantee a set USD receivable and to most effectively mitigate against unfavorable USD/GBP exchange rate fluctuations.

Background

Dozier Industries is an American company that specializes in electronic security systems. The technology firm experienced high growth for nearly a decade, followed by increased competition, which led to poor management decisions and severely reduced profits. The firm began to earn steadier profits after shifting focus to larger corporations. Management expects large foreign corporate sales to provide solid growth prospects in the future.

On January 13, 1986, Dozier Industries confirmed its first major international sales contract with a U.K. based firm. Dozier bid, and won, the project for GBP1.175 million (MM); the technology firm allowed for a 6 percent profit margin—lower than they usually contract for—to ensure the likelihood of winning the bid. The U.K. firm paid Dozier Industries 10 percent of the bid price, GBP0.1175 MM, upon contract confirmation and will pay the remaining balance of GBP1.0575 MM on the date of projected completion, April 14, 1986.

Problem

Dozier Industries must convert the received payment to USD while maintaining the highest possible profit margin. The exchange rate between the GBP and USD is constantly changing; the USD/GBP spot rate was 1.4820 on December 3, 1985. The USD/GBP spot rate decreased throughout the six weeks thereafter, to 1.4370 on January 14, 1986. As a result of GBP depreciation against the USD, Richard Rothschild—CFO of Dozier Industries—grew concerned that the remaining balance payment of GBP1.0575 MM would be unfavorably affected by the ensuing GBP to USD currency conversion.

Therefore, Mr. Rothschild has three options to best hedge his future revenue:

1. Leave the risk situation alone and doing nothing,
2. utilize a forward contract,
3. or use a spot transaction.

        The GBP may further depreciate against the USD during the term of international sale in the U.K.; if Mr.Rothschild decides to do nothing, Dozier Industries would be vulnerable to unfavorable price fluctuations. The company may encounter losses (gains) or lessoned profits if the GBP depreciates (appreciates) against the USD.

        Alternatively, Dozier Industries can hedge the exchange risk by means of a forward contract. This would mean that the firm has an obligation to deliver GBP 90 days from January 14, 1986 at the current spot rate. At the completion of the project, the firm would receive a set USD value for GBP receivable, regardless of future spot rate at maturity.