Answrers :-
Scenario 1a: Multinational transfer pricing, global tax minimisation
Requirement 1:
| Particulars | Method A | Method B |
| Internal transfers at full manufacturing cost | Internal transfers at market price | |
| US Division: | ||
| Revenues: | ||
| Cost per unit | $ 800 | $ 950 |
| Produced units | 10,000 | 10,000 |
| Revenue | $ 8,000,000 | $ 9,500,000 |
| Costs: | ||
| Full manufacturing cost | $ 8,000,000 | $ 8,000,000 |
| Division operating income | $ – | $ 1,500,000 |
| Division income tax @35% | $ – | $ 525,000 |
| Division after-tax operating income | $ – | $ 975,000 |
| Australian Division: | ||
| Revenues: | ||
| Cost per unit | $ 1,150 | $ 1,150 |
| Produced units | 10,000 | 10,000 |
| Revenue | $ 11,500,000 | $ 11,500,000 |
| Costs: | ||
| Transferred in-costs | $ 8,000,000 | $ 9,500,000 |
| Import duty per unit @15% | $ 120 | $ 142.50 |
| Import duties of transferred in-price | $ 1,200,000 | $ 1,425,000 |
| Total division costs | $ 9,200,000 | $ 10,925,000 |
| Division operating income | $ 2,300,000 | $ 575,000 |
| Division income tax @40% | $ 920,000 | $ 230,000 |
| Division after-tax operating income | $ 1,380,000 | $ 345,000 |
| Total divisional after-tax operating income | $ 1,380,000 | $ 1,320,000 |
Requirement 2:
Although there are several alternatives available for Derwent Limited, the transfer price needs to be either the overall manufacturing cost or the market value of comparable exports for reducing income taxes and import duties. For this to happen, the transfer price is raised by $1 in relation to the overall manufacturing cost of $800, which would result in modifications in cost per unit (Cristea and Nguyen 2016). This could be depicted as follows:
| Particulars | Units |
| Income tax rate | 35% |
| Increase in US taxes | $ 0.35 |
| Import duty rate | 15% |
| Increase in import duties paid in Australia | $ 0.15 |
| Australian tax rate | 40% |
| Decrease in Australian tax | $ (0.46) |
| Increase in import duty and tax payments | $ 0.04 |
The above table points out that the US tax would rise by $0.35 per unit. Similarly, the Australian import duties would rise by $0.15 per unit; however, the Australian tax expense would fall by $0.46 per unit as well. The overall outcome obtained is the rise in tax payments and import duties by $0.04 per unit.
The change in the transfer price has been made from $800 to $950 and the effects of this change are illustrated as follows:
| Particulars | Units |
| Transfer price | $ 800 |
| Change in transfer price | $ 950 |
| Increase in import duty and tax payments per dollar | $ 0.04 |
| Net increase in import duty and tax payments per unit | $ 6 |
| Production | 10,000 |
| Decrease in total profit | $ 60,000 |
It is evident that the net rise in tax payments and import duties is $6 per unit. Since the production level is 10,000 units, the total profits would fall by $60,000 and the amount could be identified as the difference in the net income of the two divisions. Therefore, minimising import duties and taxes would be a feasible solution for Derwent Limited at the level of overall manufacturing cost, which is $800 (Rugman and Eden 2017).
Scenario 1b: Multinational transfer pricing, goal congruence
Requirement 1:
| Particulars | If Transferred to USA | If sold in Australia only | ||
| Australia | USA | Australia | USA | |
| Units | 10,000 | 10,000 | 10,000 | 10,000 |
| Cost per unit | $ 900 | $ 1,150 | $ 900 | $ – |
| Sales | $ 9,000,000 | $ 11,500,000 | $ 9,000,000 | $ – |
| Less: Import cost | $ – | $ 9,000,000.00 | $ – | $ – |
| Less: Import duty @15% | $ – | $ 1,350,000.00 | $ – | $ – |
| Less: Full manufacturing cost @$800 | 8,000,000 | 0 | 8,000,000 | |
| Profit | $ 1,000,000 | $ 1,150,000 | $ 1,000,000 | $ – |
| Tax rate | 35% | 40% | 35% | 40% |
| Taxable amount | $ 350,000 | $ 460,000 | $ 350,000 | $ – |
| Profit after tax | $ 650,000 | $ 690,000 | $ 650,000 | $ – |
| Total divisional profit: | ||||
| If transferred to USA | $ 1,340,000 | |||
| If sold locally | $ 650,000 |
Requirement 2:
There would be reduction in import duties for the Australian division by transferring B12 at the overall manufacturing cost. However, it would not earn any operating profit in this case. The department aims to raise its divisional profit by increasing the sale of the product in the Australian market. The profit level would be $650,000, if the division decides to sell the product in the local market. However, by transferring the product at the overall manufacturing cost to the US division would not help the organisation in achieving the purpose (Shunko, Debo and Gavirneni 2014). Hence, it could be stated that optimum pricing structure could not be maintained, if the transfer price computed in the above section is taken into consideration.
Requirement 3:
| Particulars | If transferred to USA | |
| Australia | USA | |
| Units | 10,000 | 10,000 |
| Cost per unit | $ 900 | $ 1,150 |
| Sales | $ 9,000,000 | $ 11,500,000 |
| Less: Import cost | $ 9,000,000 | |
| Less: Import duty @15% | $ 1,350,000 | |
| Less: Full manufacturing cost @$800 | $ 8,000,000 | $ – |
| Profit | $ 1,000,000 | $ 1,150,000 |
| Tax rate | 35% | 40% |
| Taxable amount | $ 350,000 | $ 460,000 |
| Profit after tax | $ 650,000 | $ 690,000 |
| Particulars | Transfer price | |
| $800 per unit | $900 per unit | |
| Australian income taxes | $ – | $ 350,000 |
| US import duties | $ 1,200,000 | $ 1,350,000 |
| US income taxes | $ 920,000 | $ 460,000 |
| Total | $ 2,120,000 | $ 2,160,000 |
From the above tables, it is clearly inherent that the minimum transfer price, which is feasible to the divisional manager of Derwent Limited in Australia, might result in additional payment of $40,000 in the form of import duties and income tax payments. However, the transfer price would help the organisation in maintaining the desired profit margin (Davies et al. 2018).
2: Airline pricing
To,
The Directors of Eastcoast Airways,
Date: 24/05/2018
Subject: Airline pricing strategy
Based on the critical evaluation of the provided information about Eastcoast Airways, it could be found that the airline is expected to have 150 pleasure travellers and 200 business travellers, if the price per passenger is set as $600. Similarly, if the price is set at $1,350 for each passenger, the airline could expect 180 business travellers and 20 pleasure travellers. However, before recommending any particular pricing strategy, it is necessary to consider their feasibility for Eastcoast Airways and therefore, the following computations are made:
| Particulars | Option 1 | Option 2 |
| Units | Units | |
| Sales revenue | $ 600 | $ 1,350 |
| Less: Variable cost per ticket | $ 65 | $ 150 |
| Contribution per passenger | $ 535 | $ 1,200 |
| Total number of business travellers | 200 | 180 |
| Total number of pleasure travellers | 100 | 20 |
| Contribution margin from business travellers | $ 107,000 | $ 216,000 |
| Contribution margin from pleasure travellers | $ 53,500 | $ 24,000 |
From the above table, it is clearly inherent that Eastcoast Airways could expect the contribution margin to be increased, if it decides to charge $600 each from the pleasure travellers and $1.350 each from the business travellers. This implies that the strategy of price discrimination would be immensely beneficial for the airline; as such strategy would help in raising its overall profit level (Escobari, Rupp and Meskey 2016). Some information regarding other costs is provided in the case study, which are not taken into consideration in this case for arriving at the contribution margin. The costs that are excluded in this case include the following:
These cost items are considered to be irrelevant, as no change in the pricing strategy would take place, even if they increase or decrease with the passage of time (Chandra and Lederman 2018). The business travellers tend to return within the same week for work purpose, while the pleasure travellers prefer to stay in the destinations during the weekends. Hence, Eastcoast Airways might charge $600 as flight fare from those travellers intending to stay during the weekends. As a result, the price discrimination strategy would come into play between the two groups of passengers. Along with this, the airline could not be accused legally, since it is a service provider and the policy of price discrimination is followed for not eradicating competition from the sector.
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