Beacon, a division of Libra Corporation, is located in the United States. Its effective income tax rate is 30%. Another division of Libra, Falcon, is located in Canada, where the income tax rate is 40%. Falcon manufactures, among other things, an intermediate product for Beacon called XPS-2022. Falcon operates at capacity and makes 15,000 units of XPS-2022 for Beacon each period, at a variable cost of $28 per unit. Assume that there are no outside customers for XPS-2022. Because the XPS-2022 must be shipped from Canada to the United States, it costs Falcon an additional $4 per unit to ship the XPS-2022 to Beacon. There are no direct fixed costs for XPS-2022. Falcon also manufactures other products.

A product similar to XPS-2022 that Beacon could use as a substitute is available in the United States for $38.50 per unit.

Required

1. What is the minimum and maximum transfer price that would be acceptable to Beacon and Falcon for XPS-2022, and why?

2. What transfer price would minimize income taxes for Libra Corporation as a whole? Would Beacon and Falcon want to be evaluated on operating income using this transfer price?

3. Suppose Libra uses the transfer price from requirement 2 and each division is evaluated on its own after-tax division operating income. Now suppose Falcon has an opportunity to sell 8,000 units of XPS- 2022 to an outside customer for $31 each. Falcon will not incur shipping costs because the customer is nearby and offers to pay for shipping. Assume that if Falcon accepts the special order, Beacon will have to buy 8,000 units of the substitute product in the United States at $38.50 per unit.

a. Will accepting the special order maximize after-tax operating income for Libra Corporation as a whole?

b. Will Beacon want Falcon to accept this special order? Why or why not?

c. Will Falcon want to accept this special order? Explain.

d. Suppose Libra Corporation wants to operate in a decentralized manner. What transfer price should Libra set for XPS-2022 so that each division acting in its own best interest takes actions with respect to the special order that are in the best interests of Libra Corporation as a whole?