Industrial Diamonds, Inc., based in Los Angeles, has two divisions: Philippine Mining Division

- operates a mine in the Philippines containing a rich body of raw diamonds U.S. Processing Division

- processes the raw diamonds into polished diamonds used in industrial applications

The costs of the Philippine Mining Division are:

Variable cost, 4,000 pesos per pound of raw industrial diamonds

Fixed cost, 8,000 pesos per pound of raw industrial diamonds

Industrial Diamonds has a corporate policy of further processing diamonds in Los Angeles. Several diamond-polishing companies in the Philippines buy raw diamonds from other local mining companies at 16,000 pesos per round. Assume that the current foreign exchange rate is 40 pesos = $1 U.S. the costs of the U.S. Processing Division are:

Variable cost, $200 per pound of polished industrial diamonds

Fixed cost, $600 per pound of polished industrial diamonds

Assume that it takes 2 pounds of raw industrial diamonds to yield 1 pound of polished industrial diamonds. Polished diamonds sell for $4,000 per pound.

Required :

1. Compute the transfer price (in $U.S.) for 1 pound of raw industrial diamonds transferred from the Philippine Mining Division to the U.S. Processing Division under two methods: 300% of full costs and market price.

2. Assume a world of no income taxes. Also, assume that 1,000 pounds of raw industrial diamonds are mined by the Philippine Division and then processed and sold by the U.S. Processing Division. Compute the operating income (in $U.S.) for each division of Industrial Diamonds under the two transfer-pricing methods in requirement 1.

3. Assume that the corporate income tax rate is 20% in the Philippines and 35% in the United States. Compute the after-tax operating income (in $U.S.) for each division under the transfer-pricing methods in requirement 1. (Income taxes are not included in the computation of the cost-based transfer price.Industrial Diamonds does not pay U.S. taxes on income already taxed in the Philippines.)

4. Which transfer-pricing method in requirement 1 will maximize the total after-tax operating income of Industrial Diamonds? Show your computations.

5. What factors, in addition to global tax minimization, might Industrial Diamonds consider in choosing a transfer-pricing method for transfers between its two divisions?