A Linear Probability Model You Have Developed Finds There Are

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 = 0.013 (debt/equity) + 0.78 (profit margin)
A firm you are thinking of lending to has a debt-to-equity ratio of 112 percent and its expected probability of default, or bankruptcy, is estimated to be 15.35 percent. If sales are $1.55 million, calculate the firm's net income.

A) $276,100
B) $290,700
C) $196,200
D) $299,400

Correct Answer:

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