Satellite Products, Inc. owns two subsidiaries, Saturn Systems and Neptune Audio. Saturn supplies printed circuit boards used by Neptune Audio in its state of the art stereo radio. Neptune receives 20,000 boards from Saturn annually. Each radio produced requires a single board. The market price of these boards is $40. Their total variable cost of production is $20. The market price of the radios is $105. The unit variable cost of the radio is $30 excluding the cost of the circuit board. Saturn Systems is currently operating at full capacity of 35,000 boards per year .
Demand for the boards is strong and all 35,000 could be sold to outside customers. Saturn uses the full market price as the transfer price charged to Neptune Audio. The manager of Neptune Audio argues that Saturn Systems benefits from intercompany transfers because of reduced advertising and other selling costs. Thus, he wants to negotiate a lower transfer price of $35. Required: 1.Calculate the contribution margins for the two subsidiaries using the $40 transfer price. 2.Recalculate the contribution margins at the $35 price suggested by the manager of Neptune Audio. What effect would the change in transfer price have on the company as a whole? 3.Suppose that Neptune Audio operates in a country that imposes a 40% tax rate on corporate income. Saturn Systems is located in a country where the tax rate is only 10%. What would you recommend regarding the transfer price charged by Saturn for the boards transferred to Neptune?