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 = 0.18 (debt ratio) + 0.35 (profit margin)
You know a particular firm has a debt ratio of 35 percent and a probability of default of 8 percent. Calculate the firm's profit margin.

Question

Quizplus · Accepted Answer

To find the firm's profit margin, substitute the given values into the linear probability model equation: 0.08 = 0.18(0.35) + 0.35(profit margin). Solving for the profit margin gives approximately 4.857 percent.

Suppose a Linear Probability Model You Have Developed Finds There