Principles of Corporate Finance_ 12th Edition

Chapter 23 Credit Risk and the Value of Corporate Debt 611

bre44380_ch23_597-617.indd 611 09/30/15 12:08 PM

◗ FIGURE 23.8

Financial ratios of 544

failing and nonfailing

firms.

Source: W. H. Beaver, M. F.

McNichols, and J-W. Rhie,

“Have Financial Statements

Become Less Informative?

Evidence from the Ability of

Financial Ratios to Predict

Bankruptcy,” Review of

Accounting Studies 10 (2005),

pp. 93–122.

10

5

0

Return on assets, %

 5

Years before bankruptcy

(a)

4 3 2 1

Failing firms Nonfailing firms

 10

 15

 20

100

50

60

70

80

90

40

0

10

20

30

Total liabilities as % of assets

Years before bankruptcy

(b)

4321

Failing firms Nonfailing firms

40

15

20

25

30

35

10

0

5

EBITDA as % of total liabilities

Years before bankruptcy

(c)

4321

 5

 10

Failing firms Nonfailing firms

of five years. Figure 23.9 shows the range of possible values of Phlogiston’s assets when the
loan becomes due. The expected value of the assets is $120, but this value is by no means cer-
tain. There is a probability of 20% that the asset value could fall below $60, in which case the
company will default on its debt. This probability is shown by the shaded area in Figure 23.9.