A new project is projected to yield $2.5 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

The increase in the transfer price from $30 to $35 per unit for 100,000 units results in an additional cost of $500,000 ($5 increase * 100,000 units) for the project. This reduces the project's profitability by $500,000 before tax. However, after considering the local corporate profit tax rate of 40%, the net impact on the project's profitability is a reduction of $300,000 ($500,000 * (1 - 0.4)). For the parent, the additional $500,000 is income before tax. After applying the parent's marginal tax rate of 34%, the net benefit is $330,000 ($500,000 * (1 - 0.34)). However, with the incremental tax on subsidiary remittances to the parent being -3%, this effectively increases the parent's net benefit by reducing the tax burden. The final impact on the parent's profitability is $321,000 ($330,000 * (1 + 0.03)).

A New Project Is Projected to Yield $2