Express Grow

Inc., based in

Clinton,

Iowa,

sells high-end fertilizers.

Express Grow

has two divisions:

North

Italy

mining division, which mines potash in northern Italy

US processing division, which uses potash in manufacturing top-grade fertilizerThe processing division's yield is

50%:

It takes

2

tons of raw potash to produce

1

ton of top-grade fertilizer. Although all of the mining division's output of

15,000

tons of potash is sent for processing in the United States, there is also an active market for potash in

Italy.

The foreign exchange rate is

0.80

Euro = $1 US. The following information is known about the two divisions:

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Part 1

Requirement 1. Compute the annual pretax operating income, in US dollars, of each division under the following transfer-pricing methods: (a)

150%

of full cost and (b) market price.Begin by computing the operating income for the North

Italy

mining division under each method, and then calculate the operating income for the US processing division under each method.

	150% of Full Cost	Market Price
North Italy Mining division
Division revenue
Cost:
Division variable cost
Division fixed cost
Total division cost
Division operating income

Part 2

US Processing division
Division revenue
Cost:
Transferred-in cost
Division variable cost
Division fixed cost
Total division cost
Division operating income

Part 3

Requirement 2. Compute the after-tax operating income, in US dollars, for each division under the transfer-pricing methods in requirement 1. (Income taxes are not included in the computation of cost-based transfer price, and

Express Grow

does not pay US income tax on income already taxed in

Italy.)

Begin by computing the after-tax operating income for the North

Italy

mining division under each method, and then calculate the after-tax operating income for the US processing division under each method. (Enter all amounts in US dollars.)

	150% of Full Cost	Market Price
North Italy Mining division
Division operating income
Income tax
Division after-tax operating income

Part 4

	150% of Full Cost	Market Price
US Processing division
Division operating income
Income tax
Division after-tax operating income

Part 5

Requirement 3. If the two division managers are compensated based on after-tax division operating income, which transfer-pricing method will each prefer? Which transfer-pricing method will maximize the total after-tax operating income of

Express Grow?

The North

Italy

Mining Division manager will prefer the

higher

lower

transfer price of

100% of full cost

150% of full cost

market price

, and the US Procession Division manager will prefer the

higher

lower

transfer price equal to

100% of full cost.

150% of full cost.

market price.

Express Grow

will maximize companywide net income by using the

100% of full cost

150% of full cost

market price

based transfer-pricing method.

Part 6

Requirement 4. In addition to tax minimization, what other factors might

Express Grow

consider in choosing a transfer-pricing method?

The following are factors that executives consider important in transfer pricing decisions:

Part 7

The following factors are specifically related to multinational transfer pricing: (Leave unused cells blank.)

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Information

	A	B
1	North Italy Mining Division
2	Variable cost per ton of raw potash	64 EURO
3	Fixed cost per ton of raw potash	104 EURO
4	Market price per ton of raw potash	256 EURO
5	Tax rate	30%
6	US Processing Division
7	Variable cost per ton of fertilizer	$50 US dollars
8	Fixed cost per ton of fertilizer	$125 US dollars
9	Market price per ton of fertilizer	$1,110 US dollars
10	Tax rate	35%

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Required

1.	Compute the annual pretax operating income, in US dollars, of each division under the following transfer-pricing methods: (a) 150% of full cost and (b) market price.
2.	Compute the after-tax operating income, in U.S. dollars, for each division under the transfer-pricing methods in requirement 1. (Income taxes are not included in the computation of cost-based transfer price, and Express Grow does not pay U.S. income tax on income already taxed in Italy.)
3.	If the two division managers are compensated based on after-tax division operating income, which transfer-pricing method will each prefer? Which transfer-pricing method will maximize the total after-tax operating income of Express Grow?
4.	In addition to tax minimization, what other factors might Express Grow consider in choosing a transfer-pricing method?