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 = 0.28 (debt ratio) + 0.51 (profit margin)
You know a particular firm has a debt ratio of 46 percent and a probability of default of 18 percent. Calculate the firm's profit margin.

Question

Quizplus · Accepted Answer

Given the probability of default (PD_i) is 18% or 0.18, and the debt ratio is 46% or 0.46, we can substitute these values into the equation and solve for the profit margin. The equation becomes:0.18 = 0.28(0.46) + 0.51(profit margin)Solving for the profit margin gives us approximately 10.04 percent, which corresponds to option C.

Suppose a Linear Probability Model You Have Developed Finds There