American Medical Instruments produces a variety of medical products at its plant in Minneapolis. The company has sales divisions worldwide. One of the sales divisions is located in Sweden. Assume the U.S. income tax rate is 34%, Swedish rate is 60%, and a 12% import duty is imposed on medical supplies brought into Sweden.
One product produced in Minneapolis and shipped to Sweden is a heart defibrillator. The variable cost of production is $400 per unit, and the fully allocation cost is $650 per unit.
1. Suppose the Swedish and U.S. governments allow either the variable or fully allocated cost to be used as a transfer price. Which price should American Medical Instruments choose to minimize the total of income taxes and import duties? Compute the amount the company saves it if uses your suggested transfer price instead of the alternative. Assume the import duties are not deductible for tax purposes.
2. Suppose the Swedish parliament passed a law decreasing the income tax rate to 50% and increasing the duty on heart monitors to 20%. Repeat number 1, using the new facts.