Quick equity question

burning0spear

Assuming all other factors remain unchanged, which of the following would most likely lead to a decrease in the market P/E ratio?
1. A decline in the riskfree rate.
2. A decline in the rate of inflation.
3. A rise in the stock risk premium.
4. An increase in the dividend payout ratio
I chose 1 reason being, if you decrease RF using CAPM to derive K, K turns out to be higher keeping all else equal?
.07 * 1.2(.10  .07) = 10.6
.05 * 1.2(.11  .05) = 11
Higher K Higher spread under demoninator –lower PE?
What am I missing here?

JonnyKay

Seems like I am low on sugar… taking way too long to think through it.

anshultongia

true, I kept everything constant
Thanks guys

b_sea93

Also beingthatguy, k will turn out to be lower if you decline risk free rate, cuz risk free rate is being added, so part of its being offsetted, it’ll depend on beta actually as long as beta is greater than 1, a decline in rrisk free rate will increase your k. but if beta is less than 1, then decline in your risky free rate will decrease your k as well.

maxmeomeo

But if you calc out K using CAPM with a lower RF, it is still higher
Is it because the question says market PE

LiquidAssets10

cross out 4.
3 is a valid choice. higher risk premium, higher k. hence lower P/E.