Financial institutions utilize prediction models to predict bankruptcy. One such model is the Altman Z- score model, which multiple corporate income and balance sheet values to measures the financial health of a company. If the model predicts a low Z- score value, the firm is in financial stress and is predicated to go bankrupt within the next two years. If the model predicts a moderate or high Z-score value, the firm is financially healthy and is predicated to be a nonbankrupt firm. The alternative hypothesis is that the firm is predicted to be a bankrupt firm.
a. Explain the risks associated with committing a Type I error in this case.
b. Explain the risks associate with committing a Type II error in this case.
c. Which type of error do you think executive want to avoid? Explain.
d. How would changes in the model affect the probabilities of committing Type I and Type II errors?
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