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: PDi = .15 (debt ratio) + .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.

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Quizplus · Accepted Answer

The expected probability of default is calculated as follows:PDi = .15 (debt ratio) + .1 (profit margin)PDi = .15 (0.57) + .1 (0.0715)PDi = 0.0855 + 0.00715PDi = 0.09265 or 9.27%

Suppose a Linear Probability Model You Have Developed Finds There