Phipps manufactures circuit boards in Division Low in a country with a 30 percent income tax rate and transfers them to Division High in a country with a 40 percent income tax. An import duty of 15 percent of the transfer price is paid on all imported products. The import duty is not deductible in computing taxable income. The circuit boards’ full cost is $ 1,000 and variable cost is $ 700; they are sold by Division High for $ 1,200. The tax authorities in both countries allow firms to use either variable cost or full cost as the transfer price.
Analyze the effect of full- cost and variable- cost transfer pricing methods on Phipps’ cash flows.