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 equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.02 (equity multiplier) + 0.01 (total asset turnover)
A firm you are thinking of lending to has an equity multiplier of 3.2 times and a total asset turnover ratio of 1.95. Calculate the firm's expected probability of default, or bankruptcy.

A) 7.06 percent
B) 7.92 percent
C) 8.35 percent
D) 9.12 percent

Correct Answer:

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