Question

Company EJ plans to build a new plant to manufacture bicycles. EJ sells its bicycles in the world market for $400 per bike. It could locate the plant in Province P, which levies a 20 percent tax on business income. On the basis of the cost of materials and labor in Province P, EJ estimates that its manufacturing cost per bike would be $212. Alternatively, EJ could locate the plant in Province W, which levies a 16 percent tax on business income. On the basis of the cost of materials and labor in Province W, EJ estimates that its manufacturing cost per bike would be $230. Required: Calculate the after-tax profit per bike for each province. In which province should Company EJ build its new plant?

Answer 1

1(a). After-tax profit per bike for Province P = $150.40

1(b). After-tax profit per bike for Province W = $142.80

2. Company EJ should build its new plant in Province P. The reason is that the $150.40 after-tax profit per bike for Province P is greater than the $142.80 after-tax profit per bike for Province W.

Step-by-step explanation:

In the question, are given the following:

World price per bike = $400

Manufacturing cost per bike in Province P = $212

Manufacturing cost per bike in Province W = $230

Income tax rate in in Province P = 20%

Income tax rate in in Province W = 16%

Therefore, we have

1(a) Calculate the after-tax profit per bike for Province P.

Profit before tax per bike in Province P = World price per bike - Manufacturing cost per bike in Province P = $400 - $212 = $188

Tax expense per bike in Province P = Profit before tax per bike in Province P * Income tax rate in in Province P = $188 * 20% = $38.60

After-tax profit per bike for Province P = Profit before tax per bike in Province P - Tax expense per bike in Province P = $188.00 - $38.60 = $150.40

1(b) Calculate the after-tax profit per bike for Province W.

Profit before tax per bike in Province W = World price per bike - Manufacturing cost per bike in Province W = $400 - $230 = $170

Tax expense per bike in Province W = Profit before tax per bike in Province W * Income tax rate in in Province W = $170 * 16% = $27.20

After-tax profit per bike for Province W = Profit before tax per bike in Province W - Tax expense per bike in Province W = $170.00 - $27.20 = $142.80

2. In which province should Company EJ build its new plant?

Company EJ should build its new plant in Province P. The reason is that the $150.40 after-tax profit per bike for Province P is greater than the $142.80 after-tax profit per bike for Province W.