Question

In: Finance

4.   Suppose that affiliate A produces 150,000 handbags for $20 apiece and sells them to affiliate...

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.

Solutions

Expert Solution

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).


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