Weighted average cost

An inventory method that gives every unit sold and every unit left the same average cost of the goods available. Its profit and inventory figures fall between those of FIFO and LIFO.

Where you will meet it

Weighted average cost appears in 7 learning outcomes on the CFA syllabus. A few of them:

• Contrast what FCFF, FCFE, dividend and residual income models each need as inputs
  CFA Level I · Equity Investments

  “The free cash flow to firm model uses cash available to all capital providers at the weighted average cost of capital, giving firm value, from which debt is subtracted to reach equity.”

• Contrast FIFO with the weighted average cost method
  CFA Level I · Financial Statement Analysis

  “FIFO assumes the oldest units are sold first; the weighted average cost method pools all units and applies an average.”

• Set out what drives a firm's capital structure
  CFA Level I · Corporate Issuers

  “Interest is tax-deductible, so debt carries a tax shield that lowers the weighted average cost of capital — but rising leverage raises the probability and cost of financial distress.”

• Contrast valuing a business by the free cash flow available to equity (FCFE) with valuing it by its free cash flow to the whole firm (FCFF)
  CFA Level II · Equities

  “Discounting it at the weighted average cost of capital gives the value of the firm, from which the market value of debt is subtracted to reach equity.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with W · Glossary