5) South Pacific Ltd has manufacturing divisions in Australia and marketing divisions throughout the world selling South Pacific Ltd products and similar products for other companies. The South Pacific Ltd manufacturing division in Melbourne Australia produces one product the M50 for which the following cost and revenue information is available:

• Australian tax rate on Australian Division's operating income: 40%
• Variable manufacturing cost of product M50: A$340
• Full manufacturing cost of product M50: A$500
• Normal Market Price in Australia: A$650

The Melbourne division, in order to fill capacity, is discussing, with a local customer, the regular sale of 2,000 units of product M50 at a discounted price of A$580 per unit.

One of South Pacific Ltd's marketing divisions is in Poland. It currently buys a product similar to M50 from a local supplier for A$600 and sells it for A$800*

The following information relates to South Pacific Ltd's trading in Poland:

• Polish tax rate on Polish division's operating income: 20%
• Polish import duty (based on import price): 6%
• Selling price of M50 in Poland: A$800*

*All prices in Poland are quoted in A$ equivalent

The Australian and Polish tax authorities only allow transfer prices between the full manufacturing cost per unit and the Australian market price of A$650. Import duty paid to the Polish authorities is a deductible expense for calculating Polish tax due.

Required:

(a) Calculate the additional after tax profit for South Pacific Ltd if the Melbourne division sells 2,000 units of M50 in Australia at A$580 and the Polish division sells 2,000 units of the M50 equivalent, bought from the Polish supplier in Poland.

(b) South Pacific Ltd would prefer to trade with its marketing division in Poland. Calculate the after tax income which would be earned by the Australian and Polish divisions combined if they transferred 2000 units of product M50 at:

i) the highest price allowed by the tax authorities

ii) the lowest price allowed by the tax authorities

iii) the discounted price.

Explain what transfer price, complying with the tax rules, would be most profitable for the corporation as a whole.

(c) If divisional managers acted autonomously to maximize their own divisions after tax income, discuss the likely range within which the transfer price will lie, given the restrictions imposed by the tax authorities.

(d) Briefly discuss how companies trading internationally can maintain divisional autonomy and maximize profits. Relate your answer to the circumstances in the question.