In this assignment you will simulate the effective tax rates and total net incomes of different intercompany transfer prices Green Light Trading is headquartered in the U S and its manufacturing facility is based in Bulgaria (a foreign subsidiary, or foreign sub) Green Light Trading sells toaster ovens at $18 per unit to customers in the U S and incurs unit selling expenses at $2 5 per unit Green Light Trading sells 2 million units (Quantity) of toaster ovens per year Its R D expense is about $4 8 million per year and the amount of corporate expenses is $2 5 million per year Green Light Trading, Co currently only has manufacturing functions based in foreign sub while its sales, R D, and headquarter functions are all based in the U S The foreign subsidiarys total manufacturing cost per unit (cost of goods sold, or COGS) is $3 5 and the cost of shipping (Shipping) the products from the foreign country to the U S is $1 0 per unit (recorded as the selling expenses of the foreign subsidiary) At the moment the U S parent company purchases finished products from the foreign subsidiary at a mark up of $3 0 per unit The shipping cost from the foreign country to the U S is added to the purchase price paid by the U S and the price paid by the U S ( the transfer price ) is $7 5 ($3 5 $1 0 $3 0 $7 5) The foreign subsidiarys local general and administrative (Local Admin) expenses are $0 8 million per year The corporate tax rate in the U S is 25 and the corporate tax rate in the foreign subsidiary is lower than the U S corporate tax rate Assume that you are an employee of Green Light Trading, Co and you work for the tax director Determine the transfer price, effective tax rates, gross margin, net profit margin, and pretax return on sales of the U S parent, the foreign subsidiary, and the consolidated level in the following scenarios Complete the Excel worksheet below by filling out the unknowns Base case The U S parent pays a $3 0 mark up (10 ) Change the transfer price to the foreign subsidiarys COGS (exclude shipping) plus 120 COGS, i e , transfer price (TP) is (1 1 2) COGS per unit shipping cost per unit (15 ) Change the transfer price to allow the foreign subsidiary to have 50 pre tax return on sales (15 ) Hint the new transfer price (TP) can be determined by solving the following equation (TP COGS Shipping)Quantity Local Admin (TP Quantity) 50 , solve for TP The foreign subsidiary does half of the R D work and incurs R D expenses of $2 4 million ($4 80 million 50 ) As a result, the foreign subsidiary is able to charge a $8 mark up per unit Although U S parent's R D expense is reduced by $2 4 million initially, the parent company incurs additional $100,000 R D expense due to the overseeing activities needed (U S R D is $4 8 million $2 4 million $100,000 $2 5 million ) (15 ) U S parent manufactures domestically In this scenario, the foreign subsidiary is dissolved The U S cost of goods sold is estimated to be $9 per unit In addition, the U S parent is able to reduce its headquarter expenses by $500,000 Selling expense and R D expense are the same as in the base case (15 ) Green Light Trading has two general managers whose bonuses may be affected depending on the scenario the sales manager who is based in the U S and whose bonus is based on the level of gross margin and the manufacturing manager who is based in the foreign country and whose bonus is based on the pre tax return on sales Assume that these two managers both aim to maximize their bonuses Discuss which scenario (1 to 5 above) that you think will maximize Green Light Tradings shareholder values, which scenario (1 to 5 above) that you expect each manager would prefer, and what are your suggestions on the necessary changes to the performance targets of each manager that would induce them to buy in the scenario that you suggest in (20 ) Your deliverable is the Excel file for items 1 to 5 and a Word document for item 6 (at least half of a page) Please organize your Excel workbook in an understandable way with proper notations, and prepare the Word document free from grammatical errors (10 ) Note Effective tax rate is tax expense dividend by operating income Net profit margin is the net income divided by sales revenue Pre tax return on sales is operating income divided by sales revenue The Consolidation column is US foreign intercompany transactions The foreign subs sales to the US will be eliminated during consolidation Otherwise, the consolidated income statement will double count the sales revenues For example, if US sales is $10 MM, and the foreign subs sales (to US) is $3 MM, then USs COGS is the total transfer price paid by US to the foreign sub USs COGS and foreign subs sales revenue will be eliminated during consolidation Therefore, in the consolidated column, there is only USs sales revenue (to external customers) as the consolidated sales revenue, and foreign subs COGS as the consolidated COGS

The Answer is in the image, click to view ...

Answered step by step

Verified Expert Solution

Link Copied!

Question

1 Approved Answer

Posted on Jul 30, 2024

In this assignment you will simulate the effective tax rates and total net incomes of different intercompany transfer prices. Green Light Trading is headquartered in

In this assignment you will simulate the effective tax rates and total net incomes of different intercompany transfer prices.

Green Light Trading is headquartered in the U.S. and its manufacturing facility is based in Bulgaria (a foreign subsidiary, or foreign sub). Green Light Trading sells toaster ovens at $18 per unit to customers in the U.S. and incurs unit selling expenses at $2.5 per unit. Green Light Trading sells 2 million units (Quantity) of toaster ovens per year. Its R&D expense is about $4.8 million per year and the amount of corporate expenses is $2.5 million per year. Green Light Trading, Co. currently only has manufacturing functions based in foreign sub while its sales, R&D, and headquarter functions are all based in the U.S. The foreign subsidiarys total manufacturing cost per unit (cost of goods sold, or COGS) is $3.5 and the cost of shipping (Shipping) the products from the foreign country to the U.S. is $1.0 per unit (recorded as the selling expenses of the foreign subsidiary). At the moment the U.S. parent company purchases finished products from the foreign subsidiary at a mark-up of $3.0 per unit. The shipping cost from the foreign country to the U.S. is added to the purchase price paid by the U.S. and the price paid by the U.S. (the transfer price) is $7.5 ($3.5 + $1.0 + $3.0 = $7.5). The foreign subsidiarys local general and administrative (Local Admin) expenses are $0.8 million per year. The corporate tax rate in the U.S. is 25% and the corporate tax rate in the foreign subsidiary is lower than the U.S. corporate tax rate.

Assume that you are an employee of Green Light Trading, Co. and you work for the tax director. Determine the transfer price, effective tax rates, gross margin, net profit margin, and pretax return on sales of the U.S. parent, the foreign subsidiary, and the consolidated level in the following scenarios: [Complete the Excel worksheet below by filling out the unknowns.]

Base case The U.S. parent pays a $3.0 mark-up (10%)
Change the transfer price to the foreign subsidiarys COGS (exclude shipping) plus 120% COGS, i.e., transfer price (TP) is (1+1.2)*COGS per unit + shipping cost per unit (15%)
Change the transfer price to allow the foreign subsidiary to have 50% pre-tax return on sales (15%) Hint: the new transfer price (TP) can be determined by solving the following equation:
- [ (TP-COGS- Shipping)Quantity Local Admin ]/(TP*Quantity) = 50%, solve for TP
The foreign subsidiary does half of the R&D work and incurs R&D expenses of $2.4 million ($4.80 million*50%). As a result, the foreign subsidiary is able to charge a $8 mark-up per unit. Although U.S. parent's R&D expense is reduced by $2.4 million initially, the parent company incurs additional $100,000 R&D expense due to the overseeing activities needed (U.S. R&D is $4.8 million - $2.4 million + $100,000 = $2.5 million.) (15%)
U.S. parent manufactures domestically. In this scenario, the foreign subsidiary is dissolved. The U.S. cost of goods sold is estimated to be $9 per unit. In addition, the U.S. parent is able to reduce its headquarter expenses by $500,000. Selling expense and R&D expense are the same as in the base case. (15%)
Green Light Trading has two general managers whose bonuses may be affected depending on the scenario: the sales manager who is based in the U.S. and whose bonus is based on the level of gross margin; and the manufacturing manager who is based in the foreign country and whose bonus is based on the pre-tax return on sales. Assume that these two managers both aim to maximize their bonuses. Discuss which scenario (1 to 5 above) that you think will maximize Green Light Tradings shareholder values, which scenario (1 to 5 above) that you expect each manager would prefer, and what are your suggestions on the necessary changes to the performance targets of each manager that would induce them to buy in the scenario that you suggest in ? (20%)
Your deliverable is the Excel file for items 1 to 5 and a Word document for item 6 (at least half of a page). Please organize your Excel workbook in an understandable way with proper notations, and prepare the Word document free from grammatical errors. (10%)

Note:

Effective tax rate is tax expense dividend by operating income.
Net profit margin is the net income divided by sales revenue.
Pre-tax return on sales is operating income divided by sales revenue.

The Consolidation column is US + foreign intercompany transactions. The foreign subs sales to the US will be eliminated during consolidation. Otherwise, the consolidated income statement will double-count the sales revenues.

For example, if US sales is $10 MM, and the foreign subs sales (to US) is $3 MM, then USs COGS is the total transfer price paid by US to the foreign sub. USs COGS and foreign subs sales revenue will be eliminated during consolidation. Therefore, in the consolidated column, there is only USs sales revenue (to external customers) as the consolidated sales revenue, and foreign subs COGS as the consolidated COGS.