Decision Trees

What is a decision tree?

A mathematical model used to help managers make decisions when faced with choices

How does a decision tree work?

• It uses estimates and probabilities to calculate likely outcomes

• Calculating these estimates helps to decide whether the net gain from a decision is worthwhile

What is the 4 step approach to decision trees?

1. Identify the options

2. Add possible outcomes

3. Add Associated Costs, Outcome Probabilities and Financial Results

4. Calculate the Expected Values and Net Gains

What are the features of decision trees?

• Like investment appraisal, decision trees are a popular tool for management decision-making

• Output from decision trees is very sensitive to the probabilities assigned

• It is important not to use them to justify a decision, but to aid decision making