Speed Racer in Victoria makes bicycles for people of all ages. The frames division makes and paints the frames and supplies them to the assembly division where the bicycles are assembled. Speed Racer is a successful and profitable corporation that attributes much of its success to its decentralized operating style. Each division manager is compensated on the basis of division operating income.

The assembly division currently acquires all its frames from the frames division. The assembly division manager could purchase similar frames in the market for $480.

The frames division is currently operating at 80% of its capacity of 4,000 frames (units) and has the following details:

	Voltage Regulator
Direct materials ($150 per unit x 320 units)	$480,000
Direct manufacturing labour ($60 per unit x 3,200 units)	192,000
Variable manufacturing overhead costs ($30 per unit 3,200 units)	96,000
Fixed manufacturing overhead costs	$624,000

All the frames divisions 3,200 units are currently transferred to the assembly division. No frames are sold in the outside market.

The frames division has just received an order for 2,000 units at $450 per frame that would utilize half the capacity of the plant. The order has to be either taken in full or rejected totally. The order is for a slightly different frame than what the frames division currently makes but takes the same amount of manufacturing time. To produce the new frame would require direct materials per unit of $100, direct manufacturing labour per unit of $48, and variable manufacturing overhead costs per unit of $30.

1. Now consider the effect of income taxes.

1. Suppose the assembly division is located in a country that imposes a 10% tax on income earned within its boundaries, while the frames division is located in a country that imposes no tax on income earned within its boundaries. What transfer price would be chosen by Speed Racer to minimize tax payments for the corporation as a whole? Assume that only transfer prices that are greater than or equal to full manufacturing costs and less than or equal to the market price of substantially similar frames are acceptable to the taxing authorities.
2. Suppose that Speed Racer announces the transfer price computed in question 4a to price all transfers between the frames and assembly divisions. Each division manager then acts autonomously to maximize division operating income. Will division managers acting in a decentralized manner achieve the actions determined to be optimal in question 1?

2. Consider your responses to questions 1 to 4 and assume the frames division will continue to have opportunities for outside business as described in question 1. What transfer-pricing policy would you recommend Speed Racer use and why? Would you continue to evaluate division performance on the basis of division operating incomes?

3. Provide a recommendation given the case facts .