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be based on Isidore Klein's original $119 investment.
We disagree. First, petitioner cites no case in which a
court gave significant weight to a high return on equity computed
based on a founding shareholder's small initial investment.
Courts have relied on other financial factors when a
shareholder's capital contribution is small. See, e.g., Alpha
Med., Inc. v. Commissioner, T.C. Memo. 1997-464 (Court derived
return on equity by using as shareholder’s equity retained
earnings for the year at issue plus the shareholder's capital
investment, and then comparing the increase in shareholder’s
equity from prior year to the year at issue), revd. on other
grounds 172 F.3d 942 (6th Cir. 1999); Labelgraphics, Inc. v.
Commissioner, T.C. Memo. 1998-343 (annual return on equity may be
skewed in years in which the taxpayer's equity is low); H&A Intl.
Jewelry, Ltd. v. Commissioner, T.C. Memo. 1997-467. Using the
approach in Alpha Medical, Inc. v. Commissioner, supra,
petitioner’s return on equity was 2.7 percent in 1993, 2.4
percent in 1994, and 3.3 percent in 1995.
Second, Hakala testified that it is misleading to measure
return on equity based on a shareholder’s nominal investment in
the company because the shareholder may have invested capital or
sweat equity and the company may have contributed patents,
intellectual property, or other intangibles that do not appear on
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