Fowler Electronics produces color plasma screens in its Windsor, Ontario, plant. The screens are then shipped to the company’s plant in Detroit, Michigan, where they are incorporated into finished televisions. Although the Windsor plant never sells plasma screens to any other assembler, the market for them is competitive. The market price is $750 per screen.
Variable costs to manufacture the screens are $350. Fixed costs at the Windsor plant are $2,000,000 per period. The plant typically manufactures and ships 10,000 screens per period to the Detroit plant. Taxes in Canada amount to 30%, of pretax income. The Canadian plant has total assets of $20,000,000.
The Detroit plant incurs variable costs to complete the televisions of $110 per set (in addition to the cost of the screens). The Detroit plant’s fixed costs amount to $4,000,000 per period. The 10,000 sets produced each period are sold for an average of $2,500 each. The U.S. tax rate is 45% of pretax income. The U.S. plant has total assets of $30,000,000.
A. Determine the return on investment for each plant if the screens are transferred at variable cost.
B. Determine the return on investment for each plant if the screens are transferred at market price.
C. To reduce taxes, will Fowler prefer a transfer price based on cost or market price? Explain.
D. Will the top managers in each plant prefer to use cost or market price as the transfer price? Explain.
E. What method could be used to resolve potential conflict over the transfer price policy?