Question

Transfer Price Problem

ABC, a German company and XYZ, a Mexican company are related and conduct business with each other. ABC sells all the parts to XYZ for it's production. Relevant data (just trust me).... Assume all amounts are in the same currency:

ABC: German income tax rate = 14%

XYZ: Mexican income tax rate = 20%

XYZ import duty tax = 5%

ABC selling price and cost = 31 and 16

XYZ selling price = 50

ANSWER BOTH PARTS BELOW - ROUND ALL COMPUTATIONS TO FULL UNITS (NO DECIMALS)

(a) Compute the net income effect for the combined companies of one unit sold by ABC to XYZ and then sold externally. Show and label all computations.

(b) Should the transfer price be raised or lowered to maximize total profit? One word answer.

Answer 1

Requirement (a).

Particulars	ABC	XYZ	Combined
Selling price per unit	31	50	81
(-) Cost	16	31	47
(-) Import duty	0	1.55	1.55
Profit before tax	15	17.45	32.45
(-) Tax	2.1	3.49	5.59
Net Income	12.9	13.96	26.86

Requirement (b).

The Transfer Price Should be Raised.

Explanation:

The transfer price should be raised in order to maximize the profit.For example, if transfer price raised to 36,then

Particulars	ABC	XYZ	Combined
Selling price per unit	36	50	86
(-) Cost	16	36	52
(-) Import duty	0	1.8	1.8
Profit before tax	20	12.2	32.2
(-) Tax	2.8	2.44	5.24
Net Income	17.2	9.76	26.96

The Combined profit of the company is raised by 10 cents per unit transferred.

Therefore, the transfer price should be raised.