Question

Problem 2: Jonah and the Whale

Jonah, Inc. has two operating divisions in a decentralized structure. Division X is located in the US and produces the Xwater, which is an input to Division Y’s WhaleY. Division Y is located in the South of France. Division X uses idle capacity to produce Xwater. Xwater has a US domestic market price of $60. Its variable costs are $25 per unit. Jonah’s US tax rate is 40% of income. In addition to the transfer price for each Xwater received from Division X, Division Y also pays a shipping fee of $15 per unit ofXwater to get the Xwater from the US to France. The WhaleY costs an additional $10 to produce and sells for an equivalent of $115. Division Y could purchase Xwater from a Paris supplier for $50 per unit with no shipping cost. The company’s French tax rate is 70% of income. Assume French tax laws permit transferring at either variable cost or market price.

Assuming you have two choices – Variable and Market Price – what transfer price is economically optimal for Jonah, Inc.?

Answer 1

Solution:
As in problem stated that Division X is using its idle capacity to produce the product
Xwater for which variable cost for Division Y is $ 40 ($25+$15) compared to purchase
cost from a Paris supplier of $ 50 is less and hence it is beneficial for the Jonah Inc. to
transfere Xwater from Divisin X to Division Y.
Computation of transfere price economical for Jonah Inc.
Transfere at variable cost at $25
Particular		Division X	Division Y	Jonah Inc. total
Sales price/Transfere price		$25	$115	$115
Less: costs:
	Variable cost	$25	$0	$25
	Xwater transfere cost	$0	$25	$0
	Shipping cost	$0	$15	$15
	Additional production cost of WhaleY	$0	$10	$10
Total cost		$25	$50	$50
Profit		$0	$65	$65
Income tax @ 40% and 70% respectively		$0	$45.50	$45.50
Total cost for Jonah Inc. (Total cost+Income tax)				$95.50
Transfere at market price at $60
Particular		Division X	Division Y	Jonah Inc. total
Sales price/Transfere price		$60	$115	$115
Less: costs:
	Variable cost	$25	$0	$25
	Xwater transfere cost	$0	$60	$0
	Shipping cost	$0	$15	$15
	Additional production cost of WhaleY	$0	$10	$10
Total cost		$25	$85	$50
Profit		$35	$30	$65
Income tax @ 40% and 70% respectively		$14	$21	$35
Total cost for Jonah Inc. (Total cost+Income tax)				$85
So transfer price at market price of $60 is economical for Jonah Inc. as in market price
as a transfere price total cost to Jonah Inc. is less at $ 10.50 ($95.50-$85) becouse of
tax rate lower in US compared to France.