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## CMA Pop Quiz #147: Part II: Investment Decisions

Here is the answer to this week’s quiz: • 2.58 years.
• 2.14 years.
• 2.44 years.
• 3.41 years.

The payback is the length of time that it takes to recover the initial investment. The cash flow in each year is calculated as follows: Cash flow each year = (operating income)(1 − tax rate) + (annual depreciation expense)

Depreciation expense = \$400,000 / 5 years = \$80,000 per year
Cash flow each year = (operating income)(1 − 0.4) + (\$80,000)

Cash flow, year 1 = (\$150,000)(0.6) + \$80,000 = \$170,000

Cash flow, year 2 = (\$200,000)(0.6) + \$80,000 = \$200,000

Cash flow, year 3 = (\$225,000)(0.6) + \$80,000 = \$215,000

Cumulative cash flow after 2 years = \$170,000 + \$200,000 = \$370,000
Cumulative cash flow after 3 years = \$370,000 + \$215,000 = \$585,000
Payback is 2 years + (\$400,000 − \$370,000) / (\$215,000) = 2 + \$30,000 / \$215,000 = 2 years + 0.14 years = 2.14 years.

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