# What would reduce P/E ?

Assuming all other factors remain unchanged, which one of the following would reduce a firm’s price/earnings ratio? a. The dividend payout ratio increases. b. Investors become less risk averse. c. The level of inflation is expected to decline. d. The yield on risk-free asset increases. You must explain. 5 mins.

I would say D. In order to get k (in D/E/k-g), you have to use the CAPM. As the risk-free rate increases, the ke increases as well. The P/E ratio will decrease with an increase in either k or g.

a? The increase in the payout ratio would mean lower earnings (give out more in divs. and the whole growth being dependent on what the company retains or re-invests in the company). (I think!)

delta9 Wrote: ------------------------------------------------------- > a? > The increase in the payout ratio would mean lower > earnings (give out more in divs. and the whole > growth being dependent on what the company retains > or re-invests in the company). (I think!) An increase in D/E would increase the P/E ratio.

soxboys21 Wrote: ------------------------------------------------------- > delta9 Wrote: > -------------------------------------------------- > ----- > > a? > > The increase in the payout ratio would mean > lower > > earnings (give out more in divs. and the whole > > growth being dependent on what the company > retains > > or re-invests in the company). (I think!) > > An increase in D/E would increase the P/E ratio. Yes Sorry! I just realised it as I read it again!

With questions like this, although this one is different, others will give you an increase in D/E, a decrease in D/E, an increase/decrease in k, and an increase/decrease in g and ask you which variable changes P/E in the appropriate direction. If I can’t rememer, at that moment, what components do what, I just have an example. (.5)/.1-.05 = 10 THEN, I just substitute each variable (a,b,c,d) to get the right response…

Well done Soxboys.

I think its d heres my reasoning a) more divs, low earnings, hence p/e goes up b) investors become less risk averse, means they bet more, so high demand price will go up c) inflation is declining from current levels, so price in future is worth more d) leaves you with finally, please if yield on risk free asset increase, that means the returns on stocks decline, as a result price must go down.

ok most of what i wrote up was common sense, don;t think we need cfa books for this question.

> d) leaves you with finally, please if yield on risk free asset increase, that means the returns on stocks decline, as a result price must go down. that’s good…you can actually pick the right answer without the formula.