In: Finance
4. Suppose that affiliate A produces 150,000 handbags for $20 apiece and sells them to affiliate B. Affiliate B, in turn, sells these handbags for $50 apiece to an unrelated customer. The tax rate in A’s country is 30% and B’s country is 40%.
A’s costs are $3,000,000 and a typical manufacturer mark-up is 50%. B’s selling price is $7,500,000 to unrelated customers, B’s incremental costs are $2,000,000. Typical distributor fees are 20% times their local costs. Independent parties sell similar products to subsidiaries at $4,800,000
a) What transfer price per handbag should A
establish to sell the handbags to B? Justify your answer using
typical transfer price methods.
b) If A had contemplated $28 a handbag prior to your
analysis, what is the impact on consolidated profits given your
recommendation in a.
a) What transfer price per
handbag should A establish to sell the handbags to B? Justify your
answer using typical transfer price methods.
A. Calculation of consolidated profit by using cost plus method
Affiliate A |
|
Particulars |
Amount |
Manufacturing cost |
3000000 |
Add : 50% Markup |
1500000 |
Sales price for affiliate B |
4500000 |
PBTfor affiliate A |
1500000 |
Less : Tax@30% |
450000 |
PAT for affiliate A |
1050000 |
Affiliate B |
|
Particulars |
Amount |
Sales price to unrelated customers |
7500000 |
Less: Purchase cost |
4500000 |
Less : Incremental Cost |
2000000 |
Less : Distributors' fees@20% |
400000 |
PBT |
600000 |
Less : Tax@40% |
240000 |
PAT for affiliate B |
360000 |
Consolidated Profit = 1050000 + 360000
= 1410000
B. Calculation of consolidated profit by using resale method
Affiliate A |
|
Particulars |
Amount |
Sales price for B |
4800000 |
Less : COGS |
3000000 |
PBT |
1800000 |
Less: tax rate@30% |
540000 |
PAT for affiliate A |
1260000 |
Affiliate B |
|
Particulars |
Amount |
Sales price to unrelated customers |
7500000 |
Less: Purchase cost |
4800000 |
Less : Incremental Cost |
2000000 |
Less : Distributors' fees@20% |
400000 |
PBT |
300000 |
Less : Tax@40% |
120000 |
PAT for affiliate B |
180000 |
Consolidated Profit = 1260000 + 180000
= 1440000
Summary :
Affiliate A should use resale price method for determination of selling price to affiliate B. As, consolidated profit is maximize using resale price method.
b) If A had contemplated $28 a handbag prior to your analysis, what is the impact on consolidated profits given your recommendation in a.
Affiliate A |
|
Particulars |
Amount |
Sales price for B( 150000*28) |
4200000 |
Less : COGS |
3000000 |
PBT |
1200000 |
Less: tax rate@30% |
360000 |
PAT for affiliate A |
840000 |
Affiliate B |
|
Particulars |
Amount |
Sales price to unrelated customers |
7500000 |
Less: Purchase cost |
4200000 |
Less : Incremental Cost |
2000000 |
Less : Distributors' fees@20% |
400000 |
PBT |
900000 |
Less : Tax@40% |
360000 |
PAT for affiliate B |
540000 |
Consolidated Profit = 840000 + 540000
= 1380000
Recommendation
If company determine selling price of $28 per unit, his consolidated profit is reduced to 1380000. As, purchase price for affiliate B is less than both cost plus method and resale price method. Affiliate B will be earning more profit. More the profit, more the tax burden is.
Hence, company should implement selling price using resale price method where profit is maximize. As per resale price method, selling price per unit is $32 ( 4800000 /150000).