ISACA Certified Information Systems Auditor (CISA) ExamDomain 3: Information Systems Acquisition, Development and ImplementationEasy
An IS auditor is evaluating the business case for a proposed investment in a new enterprise resource planning (ERP) system. The project has an initial cost of $1,500,000. It is expected to generate annual savings of $400,000 for the first three years, $300,000 for the next two years, and then no further savings. What is the simple payback period for this investment?
- A4.00 years
- B3.50 years
- C3.75 years
- D3.00 years
Show answer & explanationAnswer & explanation
Correct answer: C. 3.75 years
The simple payback period calculates the time it takes for an investment to generate enough cash flow to cover its initial cost. In this case, the investment is recouped within 3.75 years.
Why the other options are wrong
- A. Incorrect. This would imply the investment is recovered in the fourth year, but it is recovered earlier.
- B. Incorrect. This calculation does not accurately reflect the varying annual savings.
- D. Incorrect. This would mean the investment is recovered solely from the first three years' savings, which is not enough.
Simple Payback Period
The simple payback period is the length of time required for an investment to recover its initial cost from the cash inflows it generates.
- Ignores time value of money.
- Does not consider cash flows beyond the payback period.
- Useful for quick assessment of investment recovery.
Memory trick: Money flows back, time tells the tale.