Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.15 (debt ratio) + 0.1 (profit margin)
A firm you are thinking of lending to has a debt ratio of 57 percent and a profit margin of 7.15 percent. Calculate the firm's expected probability of default, or bankruptcy.

Question

Quizplus · Accepted Answer

The expected probability of default is calculated by plugging the given values into the model: $0.15 \times 57 + 0.1 \times 7.15 = 8.57 + 0.715 = 9.285\%$. Rounding to two decimal places gives 9.27 percent.

Suppose a Linear Probability Model You Have Developed Finds There