Affiliate X sells 10,000 units to Affiliate Y per year.The marginal tax rates for X and Y,respectively,are 20 percent and 30 percent.The transfer price per unit is currently set at $1,000,but it can go as high as $1,250. Assume that Y pays a tax deductible tariff of 7 percent on imported merchandise.Calculate the increase in annual after-tax profits if the higher transfer price of $1,250 per unit is used.

Question

Quizplus · Accepted Answer

Current revenue for X: 10,000 x $1,000 = $10,000,000
Current cost for X: N/A (information not given)
Current profit for X: N/A (information not given)
Current cost for Y: $10,000,000
Current profit for Y: $10,000,000 - ($10,000,000 x 30%) = $7,000,000

New revenue for X: 10,000 x $1,250 = $12,500,000
New cost for X: N/A (information not given)
New profit for X: N/A (information not given)
New cost for Y: ($12,500,000 x 7%) + ($10,000,000 x 1.25) = $8,125,000
New profit for Y: $12,500,000 - $8,125,000 - ($12,500,000 x 30%) = $2,125,000

Increase in annual after-tax profits for Y: $2,125,000 - $7,000,000 = $-4,875,000
Thus, increasing the transfer price would result in a loss instead of a gain for Y. Therefore, the best choice is not to increase the transfer price, and the answer is C.

Affiliate X Sells 10,000 Units to Affiliate Y Per Year