decision trees

• What is a decision tree used for?

  To help managers make decisions
• How does a decision tree calculate likely outcomes?

  By using estimates and probabilities
• What does a decision tree help determine about a decision?

  Whether the net gain is worthwhile
• What is probability?

  The chance an event will occur
• What is the range of probability values?

  Between 0 and 1
• What must the total probability of all outcomes equal?

  1
• How is expected value calculated?

  By multiplying financial effect by probability
• What does net gain represent?

  The value gained from a decision
• How is net gain calculated?

  By adding expected values and deducting costs
• What are the benefits of using decision trees?

  • Logical presentation of choices
  • Simultaneous consideration of options
  • Addresses risk using probabilities
  • Considers likely costs and benefits
  • Easy to understand with tangible results
• What are the drawbacks of using decision trees?

  • Probabilities are estimates and prone to error
  • Uses only quantitative data, ignoring qualitative aspects
  • Assignment of probabilities can be biased
  • Does not necessarily reduce risk