Question

Alpha Communications, Inc., which produces telecommunications equipment in the United States, has a very strong local market for its circuit board. The variable production cost is $130, and the company can sell its entire supply domestically for $170. The U.S. tax rate is 40 percent. Alternatively, Alpha can ship the circuit board to its division in Germany, to be used in a product that the German division will distribute throughout Europe. Information about the German product and the division’s operating environment follows.
Selling price of final product: $360
Shipping fees to import circuit board: $20
Labor, overhead, and additional material costs of final product: $115
Import duties levied on circuit board (to be paid by the German division): 10% of transfer price
German tax rate: 60%

Assume that U.S. and German tax authorities allow a transfer price for the circuit board set at either U.S. variable manufacturing cost or the U.S. market price. Alpha’s management is in the process of exploring which transfer price is better for the firm as a whole.

Required:
1. Compute overall company profitability per unit if all units are transferred and U.S. variable manufacturing cost is used as the transfer price. Show separate calculations for the U.S. operation and the German division.
2. Repeat requirement (1). assuming the use of the U.S. market price as the transfer price. Which of the two transfer prices is better for the firm?
3. Assume that the German division can obtain the circuit board in Germany for $155.

a. If you were the head of the German division, would you rather do business with your U.S. division or buy the circuit board locally? Why?
b. Rather than proceed with the transfer, is it in the best interest of Alpha to sell its goods domestically and allow the German division to acquire the circuit board in Germany? Why? Show computations to support your answer.

Answer 1

Answer:

1-If the transfer price is set equal to the U.S. variable manufacturing cost, Alpha Communications will have a profit of $32.80 per circuit board with US Share as $0 and German Share as $32.80.

2-If the transfer price is set equal to the U.S. market price, Alpha Communications will have a profit of $39.20 per circuit board with US Share as $24 and German Share as $15.20. The transfer price as US market price is more effective for the Alpha Communications.

3:a- If the German division can obtain the boards in Germany for 155, it is better for the German division because due to lack of additional shipping fee and import duty, this price is more feasible for the German division.

3:b- If the company decide to sell the US circuit boards locally and allow German division to obtain the circuit boards in Germany, then Alpha Communication will have a profit of $60 per circuit board with US Share as $24 and German Share as $36.

Explanation:

1-If the transfer price is set equal to the U.S. variable manufacturing cost, Alpha Communications will have a profit of $32.80 per circuit board. The calculations are as follows:

US Operation:

Sales Revenue(Price set to variable manufacturing cost): $130

Variable Manufacturing Cost:                                              : ($130)

_________________________________________________

Contribution Margin                                                            : $ 0

German Operation:

Selling Price:                                                                         $360

Transfer Price:                                                                      ($130)

Additional Cost:                                                                    ($115)

Shippng Cost:                                                                       ($20)

Import Duty (10% of Transfer Price): 10% x 130=0.1x130=    ($13)

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Income Before Tax:                                                             $82

Income Tax (60% of Income Before Tax):60%x82           ($49.20)

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Income After Tax                                                                 $32.80

2-If the transfer price is set equal to the U.S. market price, Alpha Communications will have a profit of $39.20 per circuit board. The transfer price as US market price is more effective for the Alpha Communications. The calculations are as follows:

US Operation:

Sales Revenue(Price set to variable manufacturing cost): $170

Variable Manufacturing Cost:                                              : ($130)

_________________________________________________

Income Before Tax                                                                : $ 40

Income Tax (40% of Income Before Tax):40%x40              :($16)

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Income After Tax:                                                                   : $24

German Operation:

Selling Price:                                                                         $360

Transfer Fee:                                                                        ($170)

Additional Cost:                                                                    ($115)

Shippng Cost:                                                                       ($20)

Import Duty (10% of Transfer Price): 10% x 170=0.1x170=    ($17)

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Income Before Tax:                                                             $38

Income Tax (60% of Income Before Tax):60%x38           ($22.80)

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Income After Tax                                                                 $15.20

Total Income By Alpha Communication: $24+$15.20=$39.20

3-a: If the German division can obtain the boards in Germany for 155, it is better for the German division because due to lack of additional shipping fee and import duty, this price is more feasible for the German division.

At the lower tranfer price of 130, the total impact of transfer is given by

Transfer Price:                                                                       $130

Shippng Cost:                                                                        $20

Import Duty (10% of Transfer Price): 10% x 130=0.1x130=    $13

___________________________________________________

Total Impact                                                                          $163

It is more than the local available price, Thus the company should purchase their circuit board locally.

3-b If the company decide to sell the US circuit boards locally and allow German division to obtain the circuit boards in Germany, then Alpha Communication will have a profit of $60 per circuit board.

US Operation:

Sales Revenue(Price set to variable manufacturing cost): $170

Variable Manufacturing Cost:                                              : ($130)

_________________________________________________

Income Before Tax                                                                : $ 40

Income Tax (40% of Income Before Tax):40%x40              :($16)

_________________________________________________

Income After Tax:                                                                   : $24

German Operation:

Selling Price:                                                                         $360

Local Circuit Board Price                                                     ($155)

Additional Cost:                                                                    ($115)

_________________________________________________

Income Before Tax:                                                             $90

Income Tax (60% of Income Before Tax):60%x38           ($54)

___________________________________________________

Income After Tax                                                                 $36

Total Income By Alpha Communication: $24+$36=$60.0