Question

The Nature and Wildlife Corporation has manufacturing facilities in country A and an assembly plant in country B. In June 2017, the company will ship 1,000 units with a production cost of $65 per unit to it's plant in country B. It's operating expenses in country A are $15,000 for the month. The income tax rate in country A is 20% and in country B it is 40%. The company plans to have a transfer price of $100 per unit. The final product can be sold in country B for $140. Country B's operating expenses are $10,000 during the month. How much will the combined profits of the two operations be in April 2018? Could the company benefit by changing the transfer price to $120? Suppose the income tax rate in Country A is 40% while in country B it is 20%. what will the combined profit be if all of the numbers are the same as the original assignment description. What would be the result in question 3 if the company decreased it's transfer price to $90?

Answer 1

Country A:

Operating expense = $15000 per month

Tax rate = 20%

Production cost = $65

Shipping units = 1000

Transfer price = $100

So, Total production cost = 1000*$65 = $65000

Total expenses = $65000+$15000 = $80000

Revenue = $100*1000 = $100000

So, Profit before tax = $100000-$80000 = $20000

Income tax = 0.2*$20000 = $4000

Therefore, PAT = $16000

Company B:

Income tax = 40%

Final product selling price = $140

Operating expenses = $10000 per month

Total selling price = $140*1000 = $140000

Total expenses = ($100*1000)+$10000 = $110000

PBT= $30000

Tax = 0.4*$30000 = $12000

PAT = $18000

Combined profit for a month = $34000

Scenario 1: Transfer price increased to $120

PAT for country A = $32000

PAT for country B = $6000

Combined profit = $38000

Yes. Company benefits by this increase in transfer pricing.

Scenario 2: Suppose the income tax rate in Country A is 40% while in country B it is 20%

PAT for country A = $12000

PAT for country B = $24000

Combined profit = $36000

If companty decreased transfer price to $90,

PAT for country A = $6000

PAT for country B = $32000

Combined profit = $38000