Question

The following table shows some financial data for two companies:

	A	B
Total Assets	$1587.1	$1600.7
EBITDA	-53	77
Net income + interest	-73	31
Total liabilities	744	1467.1

1. Calculate the probability of default for the two companies.

2. Which company has the higher probability?

Answer 1

Part 1)

The probability of default for the two companies is calculated as follows:

Probability of Default = e^^{(-6.445-1.192*ROA + 2.307*Liabilities/Assets - .346*EBITDA/Liabilities)} where e= exponential value (2.718) and ROA = (Net Income+Interest)/Total Assets

Using the values provided in the question in the above formula, we get,

Probability of Default (Company A) = e^^{-6.445-1.192*(-73/1587.1) + 2.307*744/1587.1 -.346*-53/744}

Probability of Default (Company B) = e^^{-6.445-1.192*(31/1600.7) + 2.307*1467.1/1600.7 -.346*77/1467.1}

Solving further, we get,

Probability of Default (Company A) = 2.718^{^(-5.28405072)} = .51%

Probability of Default (Company B) = 2.718^{^(-4.37179479)} =1.26%

_____

Part 2)

Based on the above calculations, it can be seen that Company B has higher probability of default.