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 = 0.02 (equity multiplier) + 0.06 (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 as follows: PD_i = 0.02(equity multiplier) + 0.06(total asset turnover) Since the firm has a probability of default of 6.2 percent, we can substitute this into the equation and solve for the total asset turnover ratio: 0.062 = 0.02(1.1) + 0.06(total asset turnover) 0.062 - 0.022 = 0.06(total asset turnover) 0.04 = 0.06(total asset turnover) total asset turnover = 0.04/0.06 = 0.67 times Therefore, the best choice is B) 0.67 times.

A Linear Probability Model You Have Developed Finds There Are