6. Balanced Tire Company (A). Balanced Tire Company manufactures automobile tires for sale to retail outlets in the United States and, through a wholly owned distribution subsidiary, in neighboring Canada. Annual capacity of the U.S. factory is 700,000 tires per year, but present production is only 450,000, of which 300,000 are sold in the United States and 150,000 are exported to Canada. Federal and state income tax rates in both countries add up to 40%.

Within the United States, Balanced Tire sells to retail outlets for the U.S. dollar equivalent of C$80 per tire. After-tax profit is equivalent to C$10.80 per tire calculated as follows, with all prices expressed in the Canadian dollar equivalent of U.S. dollars.

Direct labor consists of hourly payroll costs for factory workers, and direct material is for raw mate- rial purchased in the United States. Manufacturing overhead is a fixed cost that includes supervision and depreciation. Selling and administrative costs are fixed expenses for management salaries, office expenses and rent. For its exports to Canada, Balanced Tire sells sets to its Canadian subsidiary at a U.S. dollar transfer price equal to C$56 per tire, this being U.S. manufac- turing cost of C$52 plus a C$4.00 profit. Transportation and distribution costs add an addi- tional C$2.00 per tire, and the tires are resold to Canadian retail outlets for C$80, the same equiva- lent price as in the United States. This price was arrived at independently, based on the following analysis of elasticity of demand in Canada.

Maximum profit is at a sales price of C$80.00. In making this calculation, Balanced Tire deter- mined that unit demand in Canada was a function only of the sales price. Hence, it seemed self-evident to Balanced Tire's management that a transfer price to Canada of C$80.00 per tire maximized Canada's contribution to profits at a total figure of C$1,980,000. Is Balanced Tire's present pricing strat- egy for Canada correct?

Transcribed Image Text:

Balanced Tire's U.S. Profit Calculation, Expressed in Canadian Dollars: Balanced Tres U.S. sales price per tire less direct labor in U.S. $80.00 20.00 less direct material in U.S. 20.00 less U.S. manufacturing overhead 12.00 Total manufacturing costs $2.00 U.S. factory margin 28.00 less selling and administrative costs 10.00 Pre-tax profit per tire 18.00 less 40% US income taxes 720 After-tax profit per tire in the U.S. C$10.80