Quack Concepts produces its patented drug Metafour (a duck extract used as an antioxidant) in both Hong Kong and the United States. The effective marginal tax rate is 35 percent in the United States and 17 percent in Hong Kong. No additional taxes are due in the United States from Hong Kong sales. Quack sells Metafour to U.S. consumers for $10 per bottle and has annual sales of 100,000 bottles.

a. Because the patent is an intangible asset, Quack has wide latitude in the transfer price that it sets on sales from its Hong Kong manufacturing subsidiary back to the U.S. parent company. Quack’s cost of goods sold is $1 per bottle in Hong Kong. Use Exhibit 15.5 to calculate the effective tax rate on Metafour sales for transfer prices of $1 and $10 per bottle.

b. Suppose the cost of goods sold is $0.50 per bottle if Metafour is manufactured at Quack’s U.S. plant. Where should Quack produce Metafour, based on tax considerations alone? Conduct your analysis using a $1 per bottle transfer price on sales from Hong Kong to the U.S. parent.