Universal Circuits, Inc.

FM-1 ASSIGNMENT

ON

UNIVERSAL CIRCUITS, INC.

CASE BACKGROUND

Universal Circuits, Inc. is a supplier of components of the measurement and control industry. Which is basically measurement instruments and sensors used to convert physical information such as dimensions, temperature, velocity etc. to digital format. Universal Circuits sold through its own sales subsidiaries in eleven countries and through independent sales representatives in another seventeen countries. 40% of its total sales came from its foreign operations. Its major competitors were mostly US based companies that operated almost entirely from US plants. It also had some minor competition from Japanese companies such as Hitachi and Toshiba.

Universal Circuits mostly used raw material supplies from various suppliers based in US and Europe. About one fourth of the company’s manufacturing was conducted in Ireland, United Kingdom, the Philippines and Japan. Ireland was its largest offshore facility.

The management aimed at a 25% to 35% Year on Year sales growth which was almost twice that of the annual growth of the industry. The growth was planned to be mainly self-financed with a target return on capital of 19%. They were not averse to taking loans and they followed a policy of paying no cash dividend. Their performance in the recent past was outstanding with sales increasing three fold in the past five years and net income increasing by four times. Their share price also boomed as a result of this strong performance.

It set up its operations in Ireland 1976 mainly due to three reasons. Firstly Ireland offered a 0% tax rate till 1990 and 10% thereafter. The plant location in EEC saved the 17% duty it had to pay for sales operation in EEC. Thirdly young well educated labour force provided them with the required technically skilled work force. The operations in Ireland were mostly profitable with both pre-tax return on assets and pre-tax contribution margin were above target.

Its sales was mostly immune from any change in the exchange rate between US Dollar and Irish punt as in most of its sales the quotation was done in local currency at that day’s spot rate while keeping to provision to increase the final price based on the spot rate of the day of the shipment. But its production faced currency risk if the dollar weakened against the Irish Punt in that case they will have to pay more in terms of dollars for its Irish operations. The Irish division felt Universal Circuits would in that case shift its operations to  So they needed to take a decision whether to hedge based on trends in the market currency to reduce the risk.

PROBLEM STATEMENT

1. Universal Circuit Inc.- Currency Exposure Risk

• Although all the customers are billed in US Dollar, with a direct effect to limit translation, transaction and economic exposure, the Irish subsidiary still incurs many Irish punt costs.
• Thus if the uprising trend of the US Dollar reverses, the effect will be that more US Dollars will have to be purchased on the foreign exchange market by the Irish subsidiary in order to service its punt costs. 
• Hence the company is exposed to huge long term exposure to the Dollar which means change of Net Present Value as a result of unanticipated changes in the real exchange rate.
• Every month, the subsidiary has to pay for wages, other general expenses and materials sourced from outside the US by buying punt
• The danger here is that if between the time the company has incurred the costs and the time it has to pay for them, the US$ drops in value against any of these currencies then the bills will dramatically increase in US$ value
• There are mainly three kinds of currency exchange exposure that Universal Circuits Inc. faces:

• Translation or         Accounting exposure
• Transaction Exposure
• Economic Exposure

1. US Dollar is greatly overvalued in 1984

• US had 100 Billion US Dollar trade deficit in the past year.
• It can be calculated from the given data from Exhibit 2 of the case that the US Dollar is greatly over valued by 36%
• This signifies that the exchange rate differential is greater than the relative inflation between the USA and Ireland.
• So it can be assumed that if the purchasing power parity comparison between USA and Ireland holds true then the Irish Plant are right to be concerned in regards to their fear of the US Dollar weakening against the Irish Punt.
• On the other hand PPP generally does not hold for major currencies bought for investment purposes such as the US Dollar in the short run, it only holds in the long run.

1. It is difficult to Hedge

• It is difficult to hedge companies with large economic exposures using currency features or Forward Agreements because these instruments are not long enough.
• Dynamic hedging can be used to limit the adverse impacts of the economic exposures.
• The best solution to this problem is usually to match the punt cost to the punt revenues to nullify exchange rate effects through retained earnings.

1. Gap between Onsite plant and Senior Management

• The company was pro decentralization and maintained a strong entrepreneurial mentality at the divisions by granting them full managerial responsibility.
• But the CFO of the company on the other hand felt the plants needed to focus on operations and sales divisions to focus on pricing and sales margins rather than “mess around with currencies”.
• On the other hand the Irish plant expressed concern with the added expenditure they would incur added cost of sales which would bring down their budget profit.
• The point of the CFO of universal circuits is that no one really knows in which direction the dollar will go and therefore speculating on this issue was of no real interest to those in the manufacturing business.

1. Choosing between Selective Hedging, Forwards and Options

• The problem with this method is that one doesn’t know whether a forecast is going to be right or wrong. Success cannot be anticipated, leave alone guaranteed.
• When the forecast is prepared by the company itself, there is an additional risk of the forecast turning out to be biased.

SPECIFFIC RECOMMENDATIONS AND CONCLUSION

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