Calculating the Probability of Bankruptcy a Linear Probability Model You

question 75

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 sales-to-total assets ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PD_i = .45 (debt/equity) + .01 (sales/total assets)
A firm you are thinking of lending to has a sales-to-assets ratio of 1.9 and its expected probability of default, or bankruptcy, is estimated to be 7 percent. Calculate the firm's debt ratio.

• A) 11.33%
• B) 10.18%
• C) 89.82%
• D) 7.00%

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Definitions:

Work Place

A location where people are employed and engage in various activities to earn a living.

Lemons

In economic terms, refers to the problem of asymmetric information regarding the quality of products, especially used goods that are subpar or defective.

Peaches

Refers to the sweet, juicy fruit from the Prunus persica tree, often consumed fresh, canned, or used in culinary preparations.

Adverse Selection

A phenomenon in markets where buyers or sellers have information that one party to a transaction does not have, leading to an inefficient allocation of resources.