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 = 0.21(Debt ratio) − 0.16(Profit margin).
A firm you are thinking of lending to has a debt ratio of 45 percent and a profit margin of 8 percent.
Calculate the firm’s expected probability of default, or bankruptcy?
The formula for probability of default is given as :
0.21 (Debt ratio) - 0.16 (Profit margin)
Debt ratio = 45%
Profit Margin = 8%
Putting the values in the formula, the probability of default or bankruptcy is:
0.21 (0.45) - 0.16 (0.08)
0.0945 - 0.0128
0.0817
This means that there is 8.17% or 0.0817 probability of default.
Suppose a linear probability model you have developed finds there are two factors influencing the past...
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