Suppose a Linear Probability Model You Have Developed Finds There

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 75 percent and a profit margin of 6 percent. Calculate the firm's expected probability of default, or bankruptcy.

A) 15.0 percent
B) 15.9 percent
C) 20.3 percent
D) 40.5 percent

Correct Answer:

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