Question

Inflation can have significant effects on income statements and balance sheets, and therefore on the calculation of ratios. Discuss the possible impact of inflation on the following ratios, and explain the direction of the impact based on your assumptions.

a. Return on investment

Short answer

In the case of inflation in an economy, the return on investment increases.

Step-by-step solution

Formula to compute Return on investments:

$ReturnonInvestment=\frac{\mathrm{Net}\mathrm{income}\mathrm{after}\mathrm{tax}}{\mathrm{Total}\mathrm{assets}}$

Return on investments:

The return on investment is obtained by dividing the net income after tax by the total assets.Inflation may increase the company's net income and may not affect the company's total assets. Therefore, it may lead to an increase in the return on investment.