Rapid Grow Inc., based in Des Moines, Iowa, sells high-end fertilizers. Rapid Grow has two divisions:
■ North Italy mining division, which mines potash in northern Italy
■ U.S. processing division, which uses potash in manufacturing top-grade fertilizer
The processing division’s yield is 50%: It takes 2 tons of raw potash to produce 1 ton of top-grade fertilizer. Although all of the mining division’s output of 15,000 tons of potash is sent for processing in the United States, there is also an active market for potash in Italy. The foreign exchange rate is 0.80 Euro = 1 U.S.
The following information is known about the two divisions:

Required

1. Compute the annual pretax operating income, in U.S. dollars, of each division under the following transfer-pricing methods: 

(a) 150% of full cost and 

(b) Market price.

2. Compute the after-tax operating income, in U.S. dollars, for each division under the transfer-pricing methods in requirement 1. (Income taxes are not included in the computation of cost-based transfer price, and Rapid Grow does not pay U.S. income tax on income already taxed in Italy.)

3. If the two division managers are compensated based on after-tax division operating income, which transfer-pricing method will each prefer? Which transfer-pricing method will maximize the total after-tax operating income of Rapid Grow?

4. In addition to tax minimization, what other factors might Rapid Grow consider in choosing a transferpricing method?

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Home A 3 4 5 6 Insert Page Layout North Italy Mining Division 1 2 Variable cost per ton of raw potash Fixed cost per ton of raw potash Market price per ton of raw potash Tax rate Formulas 7 8 Variable cost per ton of fertilizer 10 9 Fixed cost per ton of fertilizer Market price per ton of fertilizer Tax rate 11 U.S. Processing Division Data B Review C 92 EURO 104 EURO 304 EURO 30% 49 121 1,170 35% U.S. dollars U.S. dollars U.S. dollars