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In 2000 San Fernando Drilling shipped 300 diamond drill bits to its subsidiary in Ecuador. The drill bits were shipped at San Fernando's cost of $1 million each to avoid Ecuador's duty of 20 percent. In 2000 Ecuador's income tax on foreign subsidiaries was 35 percent and the U.S. corporate tax rate was 35 percent. In 2001 Ecuador proposes to raise the corporate tax rate to 45 percent, eliminate duties, and impose a 10 percent VAT. The U.S. rate will remain the same.

a) What action (if any) should San Fernando take on its export pricing?

b) What possible U.S. government action may result from your decision in (a)?

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