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Transfer pricing - Examples. 1. Del Norte Paper Company.

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1 del norte paper company
1. Del Norte Paper Company
  • The problem: John Powell, general manager - International Operations of Del Norte Paper’s Container Division, is faced with the question of what, if anything, should be done about the reluctance of Frank Duffy, his Italian subsidiary manager, to use linerboard manufactured by a Del Norte Paper Company mill in the United States. The Italian subsidiary, the German subsidiary and 20 outside firms have recently submitted bids to an African firm for a contract involving the manufacture of a large quantity of corrugated boxes. DNP-Italia won the contract with a bid of $400 per ton. The winning bid was based on the premise that the linerboard would be purchased in the European “Spot” market
  • In order to more clearly understand the entities involved in the case look at the diagram 1
del norte paper company
Del Norte Paper Company
  • The question to be resolved in the case analysis is what course of action would have been best for the overall corporation. The numerical analysis are shown in the tables 1 and 2, that determine the same result

Diagram 1

African Company

340

to

550

400

(325)

(460)

550

Twenty Outside

Firms

DNP Deutschland

DNP Italia

tables 1
Tables 1
  • Table 1: Transfer pricing matrix
tables 2
Tables 2
  • Table 2: Make or buy analysis
remarks
Remarks
  • As can be seen in these two tables it is unlikely that Frank Duffy’s decision has cost the firm any lost contribution in this particular instance. The “Spot” alternative shows $16 more contribution.
  • The interesting discovery is that the German subsidiary would have contributed the most, by buying “Spot” and selling at the $400 price. This allows the student to raise the question as to why the German subsidiary manager bid is so high. Three possibilities, at least, come to mind here.

1. First the manager is German and, thus, follows the rules. That is to say, the corporation wants KEA-priced and DNP-produced linerboard used and that’s exactly what he’ll do

2. A second possible reason is that the German subsidiary, like the Italian one, is viewed and measured as a profit center. Thus, the manager may simply not wish to show a negative profit contribution on each ton shipped. As can be seen below, both subsidiaries would show a loss if they used KEA-priced linerboard

remarks1
Remarks

3. Finally, is the hypothesis that the German manager full well knows what he’s doing. He may simply not want this business. He is quite possibly either at or near capacity, or believes that he will be at such a position before the order could be filled.

remarks2
Remarks
  • The possibility exists that Powell’s real concern is that he wanted Duffy to use KEA-priced and DNP-produced linerboard for tax evasion (in Italy) purposes. If the linerboard is invoiced at $385 per ton, as opposed to $235 per ton, $150 per ton of taxable income is, in effect, transferred out of Italy. This is done via the route of having a higher cost-of-goods-sold figure. Thus, while the overall contribution to the corporation may be marginally lower using KEA linerboard, the firm’s after-tax contribution might be higher. This would be true if Italy’s marginal tax rate exceeded that in the United States.
2 burger rama
2. Burger Rama
  • The problem: Jane Garton has to evaluate the convenience for the overall company of internal transfer rather than external purchasing
  • As in the Del Norte Paper Company case, it’s possible to resolve the problem defining the Transfer pricing matrix or using the “make or buy analysis”
  • As shown in the following tables, the internal transfer generates a net convenience of $1320
  • Table 1: Transfer pricing matrix
burger rama
Burger Rama
  • Table 2: “Make or buy analysis”
3 mason corporation
3. Mason Corporation
  • The problem: the president of the company has to evaluate the convenience for the overall company of internal transfer rather than external purchasing
  • As in the Del Norte Paper Company case, it’s possible to resolve the problem defining the Transfer pricing matrix or using the “make or buy analysis”
  • We assume that the fixed costs ($60000) are not differential costs generated by the internal transfer, because it’s not possible to save them in the case of external purchasing
  • In addition, try to resolve the problem assuming that fixed costs are differential elements