Delta Telecom, Inc., which produces telecommunications equipment in the United States, has a very strong local market for its circuit board. The variable production cost is $390, and the company can sell its entire supply domestically for $510. The U.S. tax rate is 40%. Alternatively, Delta Telecom can ship the circuit board to its division in Germany, to be used in a product that the German division will distribute throughout Europe. Information about the German product and the division's operating environment follows.

Selling price of final product: $1,080
Shipping fees to import circuit board: $60
Labor, overhead, additional costs of final product: $345
Import duties levied on circuit board (pd by German div):10% of transfer price
German tax rate: 60%

Assume that U.S. and German tax authorities allow a transfer price for the circuit board set at either U.S. variable manufacturing cost or the U.S. market price. Delta Telecom's management is in the process of exploring which transfer price is best for the firm as a whole.

1. Compute overall company profitability per unit if all units are transferred and U.S. variable
manufacturing cost is used as the transfer price. Show separate calculations for the U.S. operation
and the German division

2. Repeat requirement (1), assuming the use of the U.S. market price as the transfer price. Which
of the two transfer prices is best for the firm?

3. Assume the German division can obtain the circuit board in Germany for $465.
a. If you were the head of the German division, would you rather do business with your
U.S. division or buy the circuit board locally?
b. Rather than proceed with the transfer, is it in the best interest of Delta Telecom to
sell its goods domestically and allow the German division to acquire the circuit board
in Germany?
4. Generally speaking, when tax rates differ between countries, what strategy should a company
use in setting its transfer prices?