Valient, Inc. has a Pennsylvania-based division that produces electronic components, with a very strong domestic market for circuit no. 222. The variable production cost is $140, and the division can sell its entire output for $190. Valient is subject to a 30% income tax rate.Alternatively, the Pennsylvania division can ship the circuit to a division that is located in Mississippi, to be used in the manufacture of a global positioning system (GPS). Information about the global positioning system and Mississippi's costs follow.Selling price: $380Circuit shipping and handling fees to Mississippi: $10Labor, overhead, and additional material costs of GPS: $120Required: A. Assume that the transfer price for the circuit was $160. How would Pennsylvania's divisional manager likely react to a

Question

corporate decision to transfer the circuits to Mississippi? Why?B. Calculate Pennsylvania income, Mississippi income, and income for the company as a whole if the transfer took place at $160 per circuit.C. Assuming that transfers took place at a price higher than $160, would the revised price increase, decrease, or have no effect on Valient's income? Briefly explain.D. Assume that Valient moved its GPS production facility to a division located in Germany, which is subject to a 45% tax rate. The transfer took place at $180. Shipping fees (absorbed by the overseas division) doubled to $20; the German division paid an import duty equal to 10% of the transfer price; and labor, overhead, and additional material costs were $150 per GPS. If the German selling price of the GPS amounted to $450, calculate Pennsylvania income, German income, and income for Valient as a whole.E. Suppose that U.S. and German tax authorities allowed some discretion in how transfer prices were set. Given the difference in tax rates, should Valient attempt to generate the majority of its income in Pennsylvania or Germany? Why?

What will be an ideal response?

Answer 1

A. The manager would be unhappy, as the division is being forced to take a "hit" of $30 per circuit ($190 vs. $160).
B. Pennsylvania: $160 - $140 = $20; $20 - ($20 × 30%) = $14
Mississippi: $380 - $10 - $120 - $160 = $90; $90 - ($90 × 30%) = $63
Valient , Inc.: $14 + $63 = $77
C. Valient's income is unaffected, as the transfer price is a wash between the divisions. In other words, Pennsylvania's revenue is offset by Mississippi's cost.
D. Pennsylvania: $180 - $140 = $40; $40 - ($40 × 30%) = $28
Germany: $450 - $20 - $150 - $180 - ($180 × 10%) = $82; $82 - ($82 × 45%) = $45.10
Valient , Inc.: $28.00 + $45.10 = $73.10
E. Tax rates are lower in the U.S. than in Germany (30% vs. 45%). Thus, Valient would benefit if it generated the majority of its income in Pennsylvania.