ISACA Certified Information Systems Auditor (CISA) ExamDomain 3: Information Systems Acquisition, Development and ImplementationMedium
A business unit proposes a new system investment with a projected lifespan of 5 years. The initial investment is $200,000. Annual cash inflows are estimated at $60,000 for the first 3 years and $40,000 for the last 2 years. Using a simple payback period calculation, how long will it take to recoup the initial investment?
- A3 years, 8 months
- B3 years, 6 months
- C4 years, 2 months
- D4 years, 0 months
Show answer & explanationAnswer & explanation
Correct answer: A. 3 years, 8 months
Year 1: $60,000 inflow. Remaining to recoup: $200,000 - $60,000 = $140,000. Year 2: $60,000 inflow. Remaining to recoup: $140,000 - $60,000 = $80,000. Year 3: $60,000 inflow. Remaining to recoup: $80,000 - $60,000 = $20,000. At the end of Year 3, $20,000 is still needed. In Year 4, the inflow is $40,000/year. To get $20,000, it takes $20,000 / $40,000 = 0.5 years, or 6 months. Therefore, the payback period is 3 years + 6 months = 3 years, 6 months.
Why the other options are wrong
- B. This is the correct calculation: $200,000 - ($60,000 * 3) = $20,000 remaining after 3 years. Year 4 brings $40,000, so $20,000 / $40,000 = 0.5 years. Total = 3.5 years or 3 years, 6 months.
- C. This answer is incorrect based on the calculation. It implies a larger remaining amount after 3 years or a slower recoup rate in year 4.
- D. This answer is incorrect based on the calculation. It implies the full $40,000 for year 4 was needed, which is not the case.
Simple Payback Period
A capital budgeting technique that calculates the time required for an investment to generate cash inflows sufficient to recover its initial cost.
- Ignores time value of money.
- Focuses on liquidity.
- Calculated by summing annual cash inflows until initial investment is recovered.
- Useful for quick screening of projects.
Memory trick: Payback: Recover Costs, Count Years.