Response to the following problem:
During the current year International Business Company's Asian Division incurred differential production costs of $6 million for parts that are transferred to its European Division. Asian Division has substantial excess capacity. European Division uses those parts to produce the final product. In addition to the costs of the units transferred from Asian Division, European Division incurred differential costs of $8 million to produce the final product in addition to the costs of parts shipped to it from the Asian Division. Sales revenue for the final product sold by European Division is $30 million. Other companies in the same country import similar parts as European Division at a cost of $7 million. International Business Company has set its transfer price at $14 million. The tax rate in the country where Asian Division is located is 40% while the tax rate for the country in which European Division is located is 70%.
a. What would International Business Company's total tax liability for both divisions be if it used the $ 7 million transfer price?
b. What would the liability be if it used the $14 million transfer price?
c. What is the optimal transfer price from an incentive point of view, ignoring taxes? What would be each division's operating profit if this optimal incentive transfer price were used?