Tech Friendly Computer, Inc., with headquarters in San Francisco, manufactures and sells a desktop computer. Tech Friendly has three divisions, each of which is located in a different country:
a. China division-manufactures memory devices and keyboards
b. South Korea division-assembles desktop computers using locally manufactured parts, along with memory devices and keyboards from the China division
c. U.S. division-packages and distributes desktop computers
Each division is run as a profit center. The costs for the work done in each division for a single desktop computer are as follows:
China division: .............Variable cost = 900 yuan
...................................Fixed cost = 1,980 yuan
South Korea division: ....Variable cost = 350,000 won
...................................Fixed cost = 470,000 won
U.S. division: ...............Variable cost = $125
....................................Fixed cost = $325
■ Chinese income tax rate on the China division's operating income: 40%
■ South Korean income tax rate on the South Korea division's operating income: 20%
■ U.S. income tax rate on the U.S. division's operating income: 30%
Each desktop computer is sold to retail outlets in the United States for $3,800. Assume that the current foreign exchange rates are as follows:
9 yuan = $1 U.S.
1,000 won = $1 U.S.
Both the China and the South Korea divisions sell part of their production under a private label. The China division sells the comparable memory/keyboard package used in each Tech Friendly desktop computer to a Chinese manufacturer for 4,500 yuan. The South Korea division sells the comparable desktop computer to a South Korean distributor for 1,340,000 won.
Required
1. Calculate the after-tax operating income per unit earned by each division under the following transfer pricing methods: (a) market price, (b) 200% of full cost, and (c) 350% of variable cost. (Income taxes are not included in the computation of the cost-based transfer prices.)
2. Which transfer-pricing method(s) will maximize the after-tax operating income per unit of Tech Friendly Computer?