International Financial Management 6th Edition by Sanjiv Eun, Cheol Resnick, Bruce Sabherwal

Exercise 9

Affiliate A sells 5,000 units to Affiliate B per year. The marginal income tax rate for Affiliate A is 25 percent and the marginal income tax rate for Affiliate B is 40 percent. Additionally, Affiliate B pays a tax-deductible tariff of 5 percent on imported merchandise. The transfer price per unit is currently $2,000, but it can be set at any level between $2,000 and $2,400. Derive (a) a formula to determine the effective marginal tax rate for Affiliate B and, (b) a formula to determine how much annual after-tax profits can be increased by selecting the optimal transfer price.