Argone Division of Gemini Corporation is located in the United States. Its effective income tax rate is 20%. Another division of Gemini, Calcia, is located in Canada, where the income tax rate is 38%. Calciamanu factures, among other things, an intermediate product for Argone called IP-2007. Calcia operates at capacity and makes 20,000 units of IP-2007 for Argone each period, at a variable cost of $80 per unit. Assume that there are no outside customers for IP-2007. Because the IP-2007 must be shipped from Canada to the United States, it costs Calcia an additional $2 per unit to ship the IP-2007 to Argone. There are no direct fixed costs for IP-2007. Calcia also manufactures other products. A product similar to IP-2007 that Argone could use as a substitute is available in the United States for $100 per unit.
1. What are the minimum and maximum transfer prices that would be acceptable to Argone and Calcia for IP-2007, and why?
2. What transfer price would minimize income taxes for Gemini Corporation as a whole? Would Calcia and Argone want to be evaluated on operating income using this transfer price?
3. Suppose Gemini uses the transfer price from requirement 2, and each division is evaluated on its own after-tax division operating income. Now suppose Calcia has an opportunity to sell 10,000 units of IP-2007 to an outside customer for $95 each. Calcia will not incur shipping costs because the customer is nearby and offers to pay for shipping. Assume that if Calcia accepts the special order, Argone will have to buy 10,000 units of the substitute product in the United States at $100 per unit.
a. Will accepting the special order maximize after-tax operating income for Gemini Corporation as a whole?
b. Will Argone want Calcia to accept this special order? Why or why not?
c. Will Calcia want to accept this special order? Explain.
d. Suppose Gemini Corporation wants to operate in a decentralized manner. What trans fer price should Gemini set for IP-2007 so that each division acting in its own best interest takes actions with respect to the special order that are in the best interests of Gemini Corporation as a whole?