Assignment:
Delta Telecom Inc, which produces telecommunication equipment in the United States, has a very strong local market for its circuit board. The variable production cost is $390, and the company can sell its entire supply domestically for $510. The U.S. tax rate is 40 percent.
Alternatively, Delta Telecom 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 final product: $1,080
Shipping fees to import circuit board: $60
Labor, overhead, and additional material costs of final product. $345
Import duties levied on circuit board (to paid by German division): 10% of transfer price
German tax rate: 60%
Assume that the U.S. and German tax authorities allow transfer price for circuit board set at either U.S. variable manufacturing cost or the U.S. market price. Delta Telecom’s management is in the process of exploring which transfer price is best for the firm as a whole.
1. Compute overall company profitability per unit if all units are transferred and the 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 price is best for the firm?
3. Assume that the German division can obtain the circuit board in Germany for $465.
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 Delta Telecom to sell its goods domestically and allow the German division to acquire the circuit board in Germany? Why? Show computations to support your answer.
4. Generally speaking, when the tax rates differ between countries, what strategy should the company use in setting its transfer prices?