John Deere, a domestic corporation, manufactures small lawn mowers for sale in t

Question

John Deere, a domestic corporation, manufactures small lawn mowers for sale in the Unites States and abroad. Foreign sales are made through Kuboto, a wholly owned foreign corporation. John Deere’s lawn mowers cost $600 to manufacture and $100 to market, and sell for $1,000 abroad. Regardless of the transfer price used for sales by John Deere to Kuboto, the combined income from a foreign sale is $300 per lawn mower [$1,000 final sales price - $600 manufacturing cost - $100 selling expense]. However, transfer prices do affect the allocation of that combined profit between John Deere and Kuboto. At one extreme, a transfer price of $600 would allocate the combined profit of $300 entirely to Kuboto, as follows. Transaction Effect on John Deere Effect on Kuboto Manufacture lawn mowers Production cost = $600 Controlled sale Sales revenue = $600 Cost of sales = $600 Foreign selling activities Selling expense = $100 Sale to foreign customer Sales revenue = $1,000 Net profit = $0 Net profit = $300 At the other extreme, a transfer price of $900 would allocate the combined profit of $300 entirely to John Deere, as follows. Transaction Effect on John Deere Effect on Kuboto Manufacture lawn mowers Production cost = $600 Controlled sale Sales revenue = $900 Cost of sales = $900 Foreign selling activities Selling expense = $100 Sale to foreign customer Sales revenue = $1,000 Net profit = $300 Net profit = $0 The facts are the same as above. Assume that the U.S. tax rate is 35% and the applicable foreign tax rate is 45%. Using this information, determine what prices will John Deere use in each markets. Given the tax structures, how should Joh Deere allocate it’s sales, revenues and profits to maximize after-tax profits.

Explanation / Answer

The two transfer prices are $600 and $900

Profit under the two Transfer prices for John Deere, Kuboto and the organisation as a whole is calculated below:

Transfer Price : $600

Transfer Price: $900

Thus, the transfer price should be set as $900 to maximise total profits after tax.

John Deere Kuboto Company Transfer Price / Sale Price 600 1000 - Own Cost -600 -100 - Transfer Cost -600 Profit before tax 0 300 - Tax 0 300*0.45= -135 Net Profit after tax 0 165 165

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