Which of the following is a limitation of the simple rate of return method when evaluating net sales performance?

• A. It ignores the time value of money.
• B. It is based solely on cash flows rather than accounting income.
• C. It requires complex calculations involving present value factors.
• D. It always results in a higher net sales figure.

Answer: (A)

Verified step by step guidance

1. Understand the concept of the simple rate of return method: This method evaluates the profitability of an investment by dividing the accounting income by the initial investment cost. It is straightforward but has limitations.
2. Identify the key limitation of the simple rate of return method: The method does not account for the time value of money, which is a fundamental principle in financial decision-making. The time value of money recognizes that a dollar today is worth more than a dollar in the future due to its earning potential.
3. Analyze the options provided: Evaluate each option to determine which one aligns with the limitation of the simple rate of return method. For example, the method does not involve complex calculations or present value factors, so these options can be eliminated.
4. Focus on the correct limitation: The simple rate of return method is based on accounting income rather than cash flows, but its primary limitation is that it ignores the time value of money. This makes it less reliable for long-term investment decisions.
5. Conclude the reasoning: The correct answer is 'It ignores the time value of money,' as this is the most significant drawback of the simple rate of return method when evaluating net sales performance.