McGonigal Inc. is a U.S. drug manufacturer selling prescription drugs in a global market. It has a foreign subsidiary through which it distributes its product to its non-U.S. market. McGonigal?s U.S. tax rate is 35%. Its subsidiary is located in a country with a corporate tax rate of 12.5%.
For next year, McGonigal projects foreign sales (through the foreign sub) will be $500 million. The cost of goods manufactured with respect to these foreign sales will be $100 million. The company normally sells drugs to its distributors at 150% markup over cost. It is evaluating an economic argument to justify only a 50% markup for sales to its foreign distribution subsidiary. Assume that no U.S. tax will be due on profits earned by the foreign sub. How much tax expense will McGonigal save if it changes its transfer price with respect to sales to the foreign sub? (Assume that title to drugs sold to the foreign distributor passes in the U.S.)
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