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 = 0.05 (equity multiplier) + 0.02 (total asset turnover)
A firm has an equity multiplier of 1.9 times and a probability of default of 10 percent. Calculate the firm's total asset turnover ratio.

Question

Quizplus · Accepted Answer

To find the total asset turnover ratio, use the equation: 0.10 = 0.05(1.9) + 0.02(total asset turnover). Solving for the total asset turnover gives 0.25.

A Linear Probability Model You Have Developed Finds There Are