Assuming all other factors remain unchanged, which of the following would most likely lead to a decrease in the market P/E ratio? A. A decline in the risk-free rate. B. An increase in the dividend payout ratio. C. A rise in the stock risk premium.
P/E = (1 - RR)/(k - g)
To lower P/E: RR increases, g decreases and or k increases. Both a decline in the RF rate and a decline in the rate of inflation will reduce k. An increase in the stock's risk premium will increase k.
