Question

MBS is organized into two divisions—Fabrication and Marketing. Fabrication produces a product that can be sold immediately or transferred to Marketing for customization and then sold. Marketing only buys from Fabrication for quality control reasons.
Fabrication currently sells 20,000 units annually at a price of $200 per unit to outside customers. It sells an additional 10,000 units to Marketing. The unit variable cost in Fabrication is $100 and annual fixed costs are $1.0 million. Fabrication is located in a country with a 30 percent tax rate.
Marketing can sell customized units for $400 each. In addition to what it pays Fabrication, the variable costs in Marketing are $50 per unit. Annual fixed costs in Marketing are $1.2 million. Marketing is located in a country with a 20 percent tax rate.
Required: a. Suppose Fabrication would have excess capacity even with the demand from Marketing. Ignoring tax implications, what transfer price would you recommend MBS adopt? b. What would be the total taxes MBS paid under the policy you recommend in requirement (a)? (Enter your answers in dollars and not in millions of dollars.) c. Suppose Fabrication has no excess capacity. Ignoring tax implications, what transfer price would you recommend MBS adopt? d. What would be the total taxes MBS paid under the policy you recommend in requirement (c)?

a. Transfer price (Excess capacity) ------

b. Total taxes paid (Excess capacity) -----

c. Transfer price (No excess capacity) -----

d. Total taxes paid (No excess capacity) -----

Answer 1

Solution a. Fabrication has excess capacity, then transfer price would be: Variable cost (only) $ 100.00 per unit Solution b. Comptation of Total taxes to be paid by MBS Computation of Tax (Fabrication) Outside Sales Contribution per unit ($200 - $100) (a) $ 100.00 per unit No of Units sold 20000 Total Contribution (outsiders) (1) (axb) $ 20,00,000.00 (b) Transfer to Marketing Contribution per unit ($100 - $100) (c) No of Units sold (d) Total Contribution (Transfer) (11) (cxd) Total Contribution (1 + 11) $ $ 10,000.00 $ $ 20,00,000.00 Less: Fixed Costs Net Profit Tax @ 30% of Net profit ($ 1M x 30%) $ $ $ 10,00,000.00 10,00,000.00 3,00,000.00 (e) (f) Computation of Tax (Marketing) Sales Price Less: Transfer Price (Solution a) Less: Other Variable costs Contribution per unit No units Total Contribution (Marketing) Lesss Fixed Costs Net Profit Tax @ 20% of Net profit ($ 0.3M x 20%) 400.00 100.00 50.00 $ 250.00 per unit 10000 units $ 25,00,000.00 $ 12,00,000.00 $ 13,00,000.00 $ 2,60,000.00 (fxg) (h) Total Taxes paid by MBS (e+h) $ 5,60,000.00

Solution c. Fabrication has No excess capacity, then transfer price would be: Variable cost 100.00 per unit Add: Contribution Lost on Outside supply ($200 - $100) $ 100.00 $ 200.00 per unit Solution d. Comptation of Total taxes to be paid by MBS Computation of Tax (Fabrication) Contribution per unit ($200 - $100) (a) $ 100.00 per unit No of Units sold (b) 20000 Total Contribution (Fabrication) (axb) $ 20,00,000.00 Less: Fixed Costs $ 10,00,000.00 Net Profit $ 10,00,000.00 Tax @ 30% of Net profit ( $ 1M X 30%) (c) $ 3,00,000.00 Computation of Tax (Marketing) Sales Price Less: Transfer Price (solution c) Less: Other Variable costs Contribution per unit No units Total Contribution (Marketing) Lesss Fixed Costs Net Profit Tax @ 20% of Net profit ($ 0.3M x 20%) Ś $ $ (d) 400.00 200.00 50.00 150.00 per unit 10000 units 15,00,000.00 12,00,000.00 3,00,000.00 60,000.00 (dxe) $ $ $ $ (f) Total Taxes paid (c+f) $ 3,60,000.00

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