Case Study

Universal Circuits, Inc.

Submitted by –
Kshitij Srivastava ( G19070)
Abhishek Kumar ( G19053)
Rushal Shah (19089)
 Case Summary

The manager of international finance of Universal circuits organization is concerned about the
exposure of the firm to change in exchange rates. The particular concern is the exposure of
operations to changes in real exchange rates. Universal circuits is a leading supplier of
components for the measurement and control industry. The application of the products includes
blood analysers, industry automation systems, process controls, environmental controls,
pollution control, cancer research, oil exploration etc. The products were widely sold by
extensive sales force. UC got is 40% sales from outside US, where it wholly owned with sales
subsidiaries in 11 countries and another independent sales representative in 17 countries.
UC faced challenges from competitors as well where its relative strength lies in the technical
innovation, quality and reliability etc. while price is the most important competitive factor but
customers can pay for higher price as well. Most of the suppliers for UC are from US only,
though it is expandin g. 25% of UC’s manufacturing is done in Ireland where raw materials are
supplied from US counterparts.
The targeted return on capital is 19% and the growth is largely self-financed. On sales front, UC
has more than tripled to $214 million in fiscal 1983 and share prices have tenfold, which made
an equity issue of $37 million successful at a price of $37.5/share.
UC started business in Ireland due to the attractive schemes given by the Irish Development
Authority in the form of attractive tax inducements. To facilitate intercompany funds transfers,
Irish operation was established as branch of Dutch Holding company. The Irish branch was a
fully integrated research and manufacturing operation, responsible for design and development.
Labor and locally owned sourced supplies accounted for 30% of direct cost of sales. Most of the
raw material supplies were from US and the prices were based on US dollar prices.
Now, based on the philosophy of the organization, some members of the senior management felt
that the responsibility of exchange rate fluctuations and gains/losses from it should be
centralised. The calculations are done monthly about exchange rates while it is believed that the
rates won’t change drastically between the order placement and shipment of the order. Thus, to
align the sales with the order placement is important.
After receiving a telex from the controller of Irish plant, who is an integral employee at
Universal Circuits, a tough decision for hedging against the depreciation of US Dollar. If dollar
depreciates, manufacturing would be shifted from his Irish plant to the US plants, which in turn
would negatively affect his performance.
Does the Universal Circuits’ Irish controller have a convincing argument for the
weakness of the dollar? Why or why not? How would you interpret the evidence?

The controller of the Irish division does have a valid point when stating that the U.S. dollar is in
a vulnerable position due to the fact that its trade deficit is currently in excess of $100 billion and
growing. (see Exhibit 1). While Universal Circuits’ chief financial officer, Joe Merrill, is correct
when stating that the dollar is in the middle of its twenty-year range, he never mentioned which
countries currency he was comparing it to. When compared to the Irish punt, which the
controller and the company have a vested interest in it is clear that over the last twenty years the
dollar has been decreasing in value. When one analyzes the data given in Exhibit 1, it is quite
clear that since 1960 when the Punt/Dollar ratio was 0.36 it has since gone to 0.42 in 1970, to
0.53 in 1980 and finally 1.01 in present day (1984). This data plainly shows that the value of the
dollar has been steadily going down relative to that of the Punt.
The Irish controller certainly presented a very convincing argument. He argues that since the
American trade deficit has been growing, the dollar will be likely to depreciate. From 1980 to
1984 the dollar appreciated against the punt by about 50% and interest rate averaged 12.6%
during the same period. These high interest rates have caused the dollar to appreciate against
other currencies and slowed down the high inflation rate (10% in 1981) during that same period
of time. Irish controller’s main worry was that the dollar will be likely to depreciate. Over the
last 2 years inflation has fallen to 5%, much lower than the 10% rate in 1981.
A lower inflation rate could result in the US government lowering interest rates, which could
cause the US dollar to decline. Increasing trading deficit, lower inflation, and lower interest rate
signals a possible weakening dollar On the other there is a more optimistic view on the direction
of the dollar. Despite the US worsening balance on current account, the US dollar will likely to
appreciate in both nominal and real terms due to foreign capital inflows motivated by good
performances in equity and real estate markets, high real interest rate, and long-run prospects for
growth and profitability. In other words, despite its large trade deficit, the US is still seen as a
safe and profitable market to invest. 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.

Should the controller be worried about its exchange value?

In view of the fact that the dollar is the Irish subsidiary’s “functional currency”, the controller
has substantial reason to be worried about the Punt/US$ exchange rate. Changes in exchange
rates of foreign currencies can adversely affect the reported profits and the nominal net worth of
the Irish subsidiary. The Irish subsidiary incurs a significant amount of Irish punt costs. As stated
in the case, “operating and other expenses were incurred virtually entirely in Irish punt.” This
being said, due to the fact that there are no sources of revenue in punts to offset these costs,
Universal Circuits is exposed to both economic and translation exposure. Universal Circuits has
a high degree of economic exposure because if the Irish controller’s estimate of the profit margin
being highly vulnerable to any weakening of the dollar is right, then logically more US dollars
will be required by the Irish subsidiary to offset its’ punt expenses.

Case Analysis

We know that in comparison to United Kingdom, US has a govt. deficit of US $ 190 billion and
an interest rate of 11.3% on bonds
In last 4 years since 1980, US dollar has appreciated against Irish punt with starting from
0.53punt/US Dollar to 1.01 punt/US dollar.
However going by Interest rate parity in between US and UK, we get
Ft = S0 X {1+(RUK-RUS)]t
Taking an average of the interest rate from 1983 and 1984.II as given in exhibit 1, we see that

1980 1983 1984.II

United States
Interest Rate 11.40% 11.30% 13.50%
Exchange rate 1 1 1

United Kingdom
Interest Rate 13.80% 10.80% 11.20%
Exchange rate 0.53 0.88 1.01
Ft 0.54272 0.8756 0.98677

overvalue 2.40% -0.50% -2.30%

As it can be seen here, US is trading at a value higher than the current system of IRP state it
should be, hence it is a good time to invest in the Irish punts if the need be for Pierre Bourquin.
Checking the same against the Industrial Prices on the PPP formula
PUK=S0 x PUS

1980 1983 1984.II

United States
Industrial Prices (Manuf.) 100.00 115.00 118.00

United Kingdom
 Industrial Prices 100.00 100.00 100.00
S0 (Calculated) 1 1.15 1.18
S0 (actual) 0.53 0.88 1.01

A lower actual S0 indicates that the overall production prices in Ireland are cheaper in
comparison to the Production prices in US.
It is also clear that it is the Ireland which has the most manufacturing outside of the US and in
considerable amount and thus it is the only currency against which Dollar rate fluctuation can
disrupt the operational effectiveness of the company.

CONCLUSION:
Hence, it is clear that while production in Ireland is cheap as of now, the US dollar itself is a bit
overvalued in comparison to the punt. Hence, there is a chance that when the balancing happens,
there may be some losses to Universal Inc. Hence it would be a better option to hedge against the
depreciation of dollars to make sure that the overall operations of the company are not effected
by the fluctuations of the international market.