CFA Practice Question

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CFA Practice Question

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 yield on Treasury bills increases.

User Contributed Comments 19

User Comment
kalps Ke will also increase as investor require a higher rate of return hence 1/Ke - g will will fall
geet For the last choice. If you increase the risk free rate the return on equity may increase or decrease depending on beta. I think B in correct. If an investor is less risk averse...he's riskier. Therefor the return on equity increases and therefor P/E ratio decreases.
EBIII if T-Bills increase the cost of capital (ke) will increase and the spread becoming wider will decrease the P/E ratio :-)
armanaziz correction to geet: a riskier investor requires a lower return on equity - not higher!
tengo Under choice a the growth factor will clearly decline reducing the ultimate p/e but so will an increase in t-bill rates produce the same outcome for different reasons
danlan2 A can increase P/E ratio
george2006 both A and the last choice will reduce P/E. When payout ratio increases, g goes smaller ==> Growth Factor ==> P/E will decrease.
volkovv A can increase P/E; P/E = (1-b) / (r-g), as payout (1-b) increases and if numerator effect will dominate decrease in g in denominator, P/E will increase, that's why yield on Treasury bills is most appropriate here
achu A will increase Price ( assuming DDM, D/(k-g)) but NOT affect earnings E which stay constant - only the allocation of payout vs retention changes. Choice B means k cost of capital goes down, which brings price UP . The correct choice means cost of capital increases, Price goes down, P/E goes down
octavianus achu, well done
cahiz84 RFR increase, K increases, K-g gap increases, D/K-G decreases
JCopeland If payout ratio increases it won't necessarily increase price for example payout ratio is 50% earnings are $2. ROE and ROR= 10%. G is (.1*.5) or 5% and DDM gives us $1/(.1-.05)=$20 Payout increases to 100%. Growth is 0 (.1*.0) Therefore, $2/(.1-0)= $20. This does not affect P/E but will definitely affect PEG. Choice C is the correct choice as it changes cost of capital and from a purely economic perspective short term interest rates and investment demand move in opposite directions.
dcfa I dont get why A is not right ? can someone help -
as div payout increases, retention rate(RR) decreases (RR=1-div payout ratio)
growth rate g=RR x ROE, so g decreases
as g decreases, k-g widens, so Price decreases
so P/E should decrease
hks101 dcfa, the question says "assuming all other factors remain unchanged." payout increases, dividend (the numerator) will increase. g remains the same b/c the question says so.
Skrills it is a tricky question. even though it says "all other factors remain unchanged" it is hard not to assume that an increased dividend will by default be subtracted out of the price of the security. am i correct or way off on thinking this?
gill15 This will make it easier for you dcfa

P/E = Payout ratio / (r - g)

Increase PR, Increase P/E
GBolt93 P/E=Payout/(r-g)
Increase dividend increases numerator: higher p/e
Less risk averse: lower required return, smaller denom, higher P/E
Higher Rf: higher Denom, lower P/E
NOBAN I think I can marry this with crowding out effect in corporate finance. Increase in government spending leads to borrowing at higher rate - local borrowing inclusive- Hence corporate bodies must pay more. This translates to higher earning request by providers of capital. Nice one
Berrondo If interest goes up, price of shares goes down. Ratio drops. Right?
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