FINANCE-Xerox Miscopies Foreign Interest Rate Data On

May 31, 2001

FINANCE-Xerox Miscopies Foreign Interest Rate Data On May 31, 2001

Question
41504_Pt6_Case_Studies_p710-711

3/8/02

7:06 AM

Page 710

Part VI Case Studies

Case VI41504_Pt6_Case_Studies_p710-711

3/8/02

7:06 AM

Page 710

Part VI Case Studies

Case VI.1

Xerox Miscopies Foreign Interest Rate Data

On May 31, 2001, Xerox disclosed in a filing

with the Securities and Exchange Commission
(SEC) that several years earlier it had changed
the way in which some of its foreign affiliates
booked revenues from copiers leased to customers. The company said that the effect of
this change in accounting practices, which
involved changing the discount-rate assumptions on its leases, was to add $253 million to
Xerox’s pretax income over the past three years.
In response, the SEC launched an investigation to determine if Xerox changed its
leaseaccounting assumptions in order to artificially
boost revenues and profits in Latin America
and elsewhere. A Xerox spokesman stated that
the company had used proper accounting
assumptions in booking lease revenues and that
it only disclosed this practice because it was
already under scrutiny for misapplying other
accepted accounting rules related to its copier
business.
1/5
Xerox typically leases copiers to customers
for periods of three to ?ve years. The accounting
assumptions in question relate to the discount rate
Xerox used to value the future stream of lease
payments. For example, a customer who buys
a copier priced at $10,000 on a ?ve-year lease
will pay a ?xed monthly lease payment for the
next 60 months. The size of the monthly payment
depends on the implicit interest rate associated
with the lease (which takes into account the time
value of money and risk) and the assumed residual value of the copier when the lease expires.
In
general, the lease payment is the solution L to the
following equation:
P?

?
t
t?1 (1 ? r)

?R

where
P ? the price of the copier
R ? the residual value in present value terms
n ? the number of months in the lease
r ? the monthly interest rate imbedded in the
lease
To illustrate, suppose the implicit interest
rate is 12% (1% monthly), the lease term is
five years, the price is $10,000, and the residual value in present value terms is $2,000.
Substituting these numbers into the equation
yields a monthly lease payment of $178. The
value of the lease receivable given the lease
payments and assumed residual value in this
illustration is $8,000. However, if the interest
rate used to value the lease payments for
accounting purposes differs from the interest
rate used to set the lease payments in the first
place, then the booked value of the lease will
differ from its economic value. In particular, if
the interest rate for valuation purposes is below
the interest rate used to set lease payments, the
value of the lease receivable will be overstated.
According to the Wall Street Journal (June 1,
2/5
2001, p. C1), this is what happened. In the
late 1990s, senior executives at Xerox ordered
the company’s Mexican subsidiary to use a discount rate well below local interest rates to
value the peso lease receivables it was generating. For example, in 1996, Xerox Mexico
booked leases using a discount rate of 20%.
That rate was progressively lowered over the
next three years, to 18% in 1997, 10% in
1998, and 6% in 1999. Comparable Mexican
interest rates during this period were 34.4% in
1996, 22.5% in 1997, 24.5% in 1998, and
24.1% in 1999. Similar aggressive interest rate

710

41504_Pt6_Case_Studies_p710-711

3/8/02

7:06 AM

Page 711

Case VI.1 • Xerox Miscopies Foreign Interest Rate Data

assumptions were used in other foreign units
as well to book revenues and value their lease
receivables.
Managers at Xerox’s business units were given
bonuses for meeting or exceeding aggressive revenue targets. Evidently, managers at these
units
?gured out how to get their bonuses.

711

4.

Questions
1. What is the purpose and consequence of

using a discount rate that is close to the market interest rate in valuing lease rentals?
2. Why were interest rates so high in Mexico in
the late 1990s? What factors were built into
these interest rates?
3. Assuming a $10,000 copier price and $3,500
residual value in present value terms, what
was the consequence of Xerox Mexico booking peso revenues using interest rates of
18% in 1997, 10% in 1998, and 6% in 1999
instead of the comparable Mexican interest
rates during this period of 34.4% in 1996,
22.5% in 1997, 24.5% in 1998, and 24.1%
3/5
in 1999? That is, on each $10,000 copier
lease, how much revenue did Xerox Mexico

5.

6.

7.

book in each? Compare those figures to their

present values using the market rates.
Apparently, Xerox used similarly rosy assumptions in Brazil as well. Instead of using a discount
rate on the order of 30%, Xerox used
a 6% discount rate to record real revenues.
Assuming the same $10,000 copier price and
$3,500 residual value in present value terms,
how much revenue was booked by using
a 6% discount rate on a 60-month lease?
Compare this ?gure to its present value using
a 30% discount rate.
How did the use of low discount rates help
managers at Xerox Mexico get their bonuses?
How might these low discount rates affect the
amount of exchange risk that managers were
willing to tolerate?
Suppose Xerox tried to sell its foreign lease
receivables to an investor. What could you
say about the price it would likely receive as
compared to their book values? Explain.
Do you agree or disagree with Xerox’s claim
that it used proper accounting assumptions
in booking its revenues and recording asset
values for foreign lease receivables? Explain.

41504_Pt6_Case_Studies_p710-711

3/8/02

7:06 AM

Page 712

FINANCE-Xerox Miscopies Foreign Interest Rate Data On May 31, 2001

Attachments
4/5
 SOLN.ZIP (18.96 KB)

Preview not available.

GET THE ANSWER>> https://solutionlly.com/downloads/finance-xerox-miscopies-foreign-

interest-rate-data-on-may-31-2001

5/5
Powered by TCPDF (www.tcpdf.org)