11-73 Suppose that debt-equity ratio (D/E)and the sales-asset ratio (S/A)were two factors influencing the past default behavior of borrowers.Based on past default (repayment)experience,the linear probability model is estimated as: PDi = 0.5(D/Ei)+ 0.1(S/Ai).If a prospective borrower has a debt-equity ratio of 0.4 and sales-asset ratio of 1.8,the expected probability of default is

Question

Quizplus · Accepted Answer

Using the given linear probability model, we can calculate the expected probability of default as follows:
PDi = 0.5(D/Ei) + 0.1(S/Ai)
PDi = 0.5(0.4) + 0.1(1.8)
PDi = 0.2 + 0.18
PDi = 0.38

Therefore, the expected probability of default is 0.38 or 38%. The best choice is C).

11-73 Suppose That Debt-Equity Ratio (D/E)and the Sales-Asset Ratio (S/A)were