CFA Practice Question

CFA Practice Question

In an environment of rising prices, the use of FIFO rather than Average Cost will result in:
A. Lower Working Capital
B. Same Equity
C. Lower Cash Flow
Explanation: Average Cost results lie between LIFO and FIFO. So FIFO vs. Average Cost will have same qualitative results as FIFO vs. LIFO. In FIFO the older units (which are cheaper than recently produced units due to rising prices) are sold before the newer units, thus producing lower COGS, higher EBIT, higher Income Taxes and then lower cash flows. FIFO also results higher Ending Inventory Balance and higher Equity.

User Contributed Comments 2

User Comment
andrewmorgan HIGHER ending inventory balances - as we have more recent stock at higher prices.

HIGHER equity - as EBIT and net income is higher and therefore retained earnings may be higher - although this depends on the payout surely.
harrybay Why is cash flow lower when EBIT is higher?
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