Calculation of Bankruptcy Probability A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PD_i = .04 (equity multiplier) + .01 (total asset turnover)
A firm has an equity multiplier of 1.5 times and a probability of default of 7 percent. Calculate the firm's total asset turnover ratio.

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The correct answer is A.The firm's probability of default is 7%, or 0.07. Substituting this value into the linear probability model, we get:0.07 = 0.04 (1.5) + 0.01 (total asset turnover)0.07 = 0.06 + 0.01 (total asset turnover)0.01 (total asset turnover) = 0.01total asset turnover = 1.0

Calculation of Bankruptcy Probability a Linear Probability Model You Have