Calculating the Probability of Bankruptcy a Linear Probability Model You

question 6

Multiple Choice

Calculating the Probability of Bankruptcy A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PD_i = .02 (debt/equity) + .80 (profit margin)
A firm you are thinking of lending to has a debt-to-equity ratio of 110 percent and its expected probability of default, or bankruptcy, is estimated to be 8 percent. If sales are $2 million, calculate the firm's net income.

• A) $145,000
• B) $165,000
• C) $160,000
• D) $200,000

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