Calculation of Bankruptcy Probability Suppose a Linear Probability Model You

question 61

Multiple Choice

Calculation of Bankruptcy Probability 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:
PD_i = 0.20 (debt ratio) + 0.15 (profit margin)
A firm you are thinking of lending to has a debt ratio of 55 percent and a profit margin of 10 percent.Calculate the firm's expected probability of default,or bankruptcy.

• A)12.5 percent
• B)10.0 percent
• C)1.65 percent
• D)10.25 percent

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Definitions:

Scrap Value

The estimated resale value of assets at the end of their useful life or the value of leftover materials after the production process.

Operating Income

The profit realized from a business's core operations, excluding deductions of interest and taxes.

Depreciation

The systematic allocation of the cost of a tangible asset over its useful life, reflecting its consumption or wear and tear.

Investment

This is the allocation of resources, usually money, in the expectation of generating an income or profit.