Reference no: EM132742113

Trudat Corporation, headquartered in Canada, manufactures milling machines. It has two marketing subsidiaries, one in the United States and one in Mexico that sell its products. Trudat is building one new machine, at a cost of $500,000. There is no market for the equipment in Canada.

The equipment can be sold in the United States for $1,000,000, but the United States subsidiary would incur transportation and modification costs of $200,000. Alternatively, the equipment can be sold in Mexico for $950,000, but the Mexican subsidiary would incur transportation and modification costs of $250,000.

The Canadian company can sell the equipment to either its United States subsidiary or its Mexican subsidiary but not both. Trudat Corporation and its subsidiaries operate in a much decentralized manner. Managers in each company have considerable autonomy, with each manager interested in maximizing company income.

REQUIRED:

Problem a) From the viewpoint of Trudat and its subsidiaries taken together, should Trudat  Corporation manufacture the equipment? If it does, where should it sell the  equipment to maximize total operating income? (Ignore tax effects)

Problem b) What is the minimum transfer price that Trudat Corporation (Canada) would be willing to accept independently of the subsidiaries?

Problem c) What are the maximum transfer prices that the United States and Mexico subsidiaries would be willing to accept independently of each other?

Problem d) The effective tax rates for this transaction are as follows: 40% in Canada, 65% in the United States, and 10% in Mexico. The tax authorities in the three countries are uncertain about the cost of the intermediate product and will allow any transfer price between $500,000 and $710,000. If Trudat and its subsidiaries want to maximize the combined net income, where should the equipment be transferred to and at what price?

Problem e) Suppose all the managers act autonomously to maximize their own company's after-tax operating income. The tax authorities will allow transfer prices only between $500,000 and $710,000. Which subsidiary will get the product and at what price?