A new project is projected to yield $million annually in after-tax profit, based on a local corporate profit tax rate of 40%. However, this profit figure depends on the use of a transfer price of $30 per unit on a component bought from the parent. If the project requires 100,000 units of this component annually, the impact on project profitability and on parent profitability of a boost in the transfer price to $35 will be _______ and _______, respectively. The parent's marginal tax rate is 34% and the incremental tax on subsidiary remittances to the parent is -3%.

Question

Quizplus · Accepted Answer

With a transfer price increase to $35 per unit, the total cost of the component for the subsidiary will increase by $5 per unit or $500,000 annually. This, in turn, will decrease the subsidiary's profit by $500,000. However, the increase in the transfer price will also increase the parent's profit on the component, as they will receive an additional $5 per unit or $500,000 annually. Considering the tax implications, the parent's after-tax profit will be $330,000 ($500,000 * (1 - 0.34)), and the subsidiary's after-tax profit will decrease by $300,000 ($500,000 * (1 - 0.4) * (1 + 0.03)). So the impact on project profitability is -$300,000 and the impact on parent profitability is +$321,000. Therefore, the correct answer is C.

A New Project Is Projected to Yield $Million Annually in After-Tax