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 = .02 (equity multiplier) + .06 (total asset turnover)
A firm has an equity multiplier of 1.1 times and a probability of default of 6.2 percent. Calculate the firm's total asset turnover ratio.

Question

Quizplus · Accepted Answer

We can use the given linear probability model to solve for the total asset turnover ratio (TATR) of the firm. PD_i = .02 (equity multiplier) + .06 (total asset turnover) Substituting the given values: 0.062 = 0.02(1.1) + 0.06(TATR) Simplifying: 0.062 = 0.022 + 0.06(TATR) 0.06(TATR) = 0.04 TATR = 0.04/0.06 = 0.67 times Therefore, the firm's total asset turnover ratio is 0.67 times. Option B is the right choice.

A Linear Probability Model You Have Developed Finds There Are