Decision trees

• What is a decision tree?

  A mathematical model for decision-making
• How does a decision tree help managers?

  It calculates likely outcomes using estimates
• What does a decision tree help determine?

  Whether the net gain is worthwhile
• What are the steps to construct a decision tree?

  1. Identify the decision to be made
  2. List options available
  3. Estimate probabilities and outcomes
  4. Calculate expected values and net gains
• What does the expected value represent in a decision tree?

  The financial value of an outcome
• How is net gain calculated?

  Expected value minus associated costs
• What are the benefits of using decision trees?

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

  • Probabilities are estimates and prone to error
  • Ignores qualitative aspects of decisions
  • Bias in assigning probabilities and values
  • Does not necessarily reduce risk
• What does the total probability of outcomes in a decision tree add up to?

  1
• What do circles represent in a decision tree?

  Uncertain outcomes
• Which option has a higher net gain?

  Cutting prices
• What does a decision tree start with?

  A decision to be made