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the balance sheet. He testified that the rate of return on
equity is best measured by comparing the company’s operating
return to the fair market value of its operating assets.
Petitioner did not respond to Hakala’s analysis on this point.
Hakala stated that an independent investor would have expected an
average net operating return on assets of about 20 percent in the
years in issue, and that petitioner’s operating returns, which
ranged from 0.7 percent to 5.26 percent in the years in issue,
were far below the returns that would have satisfied an
independent investor. Thus, we give little weight to
petitioner’s use of Isidore Klein’s $119 initial capital
contribution to calculate return on equity for 1993, 1994, and
1995.
Petitioner also contends that it did not need to pay
dividends because a hypothetical shareholder would be satisfied
with the appreciation in value of his or her stock due to
petitioner's retention of earnings and the growth in petitioner's
annual sales. We disagree. Although Hakala testified that an
investor would be happy with a return of $1,874,112 (the
redemption price of Isidore and Gertrude Klein’s stock) on $119
(Isidore Klein’s capital investment), he also stated that it is
inappropriate in this case to analyze rate of return based on
Isidore Klein’s $119 investment.
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