American Medical Instruments produces a variety of medical products at its plant in Minneapolis. The company has sales divisions worldwide. One of these sales divisions is located in Uppsala, Sweden. Assume that the US income tax rate is 34 per cent, the Swedish rate is 60 per cent, and a 12 per cent import duty is imposed on medical supplies brought into Sweden.

One product produced in Minneapolis and shipped to Sweden is a heart defibrillator. The variable cost of production is $400 per unit and the fully allocated cost is $650 per unit.

1. Suppose the Swedish and US governments allow either the variable or fully allocated cost to be used as a transfer price. Which price should American Medical Instruments choose to minimise the total of income taxes and import duties? Compute the amount the company saves if it uses your suggested transfer price instead of the alternative. Assume import duties are not deductible for tax purposes.

2. Suppose the Swedish parliament passed a law decreasing the income tax rate to 50 per cent and increasing the duty on heart monitors to 20 per cent. Repeat number 1, using these new facts.