The Questron Company manufactures telecommunications equipment at its plant in Scranton, Pennsylvania. The company has marketing divisions throughout the world. A Questron marketing division in Hamburg, Germany, imports 100,000 broadband routers from the United States. The following information is available:
U. S. income tax rate on the U. S. division’s operating income....... 35%
German income tax rate on the German division’s operating income .... 40%
German import duty ...................... 15%
Variable manufacturing cost per router ............... $ 275
Full manufacturing cost per router ................. $ 400
Selling price (net of marketing and distribution costs) in Germany ..... $ 575
Suppose the United States and German tax authorities only allow transfer prices that are between the full manufacturing cost per unit of $ 400 and a market price of $ 475, based on comparable imports into Germany. The German import duty is charged on the price at which the product is transferred into Germany. Any import duty paid to the German authorities is a deductible expense for calculating German income taxes.
1. Calculate the after- tax operating income earned by the United States and German divisions from transferring 100,000 broadband routers
(a) At full manufacturing cost per unit and
(b) At market price of comparable imports. (Income taxes are not included in the computation of the cost- based transfer prices.)
2. Which transfer price should the Questron Company select to minimize the total of company import duties and income taxes? Remember that the transfer price must be between the full manufacturing cost per unit of $ 400 and the market price of $ 475 of comparable imports into Germany. Explain your reasoning.