A subsidiary company located in country A purchases $1 00 worth of goods. It then repackages, exports, and sells those goods to the parent company, located in country B, for $200. The parent company sells the goods for $300. Therefore, both entities have a $100 profit. Assume that the income tax rate in country A is 20 percent, while the tax rate in country B is 60 percent.

Required

1. Given the above facts and assumptions, what is the company’s combined (i.e., worldwide) after-tax income for this transaction? (Show calculations.)

2. Consider now a transfer-pricing approach in which the subsidiary sells the goods to the parent company for $280, and the parent company then sells the goods for $300. What is the revised worldwide (i.e., combined) after-tax profit for this transaction? (Show calculations.)

3. What is the effect of the transfer-pricing decision when the income-tax rates for the two countries in question are equal?

4. What limitations exist regarding the setting of transfer prices for multinational transfers?