3.3.3.3 Decision Trees

Define decision trees

simple and visual way of presenting the alternative course of action available when making a decision

Helps managers make decisions and decide if the net gain from a decision is worthwhile.

What are decision trees used to identify?

• When a decision has to be made

• The choices available

• The cost associated withe ach option

• The possible outcomes related to each choice

• The likelihood (probability) of each outcome occurring

• The estimated financial result of each outcome

What does a square represent?

Decision node. This is used where a decision must be made.

What does a circle represent?

Chance node. This is used where there are a number of possible outcomes.

List three advantages of a decision tree

• clearly shows options available

• encourages logical thinking

• allows structured discussions and comparisons

• takes risk into account

• may raise alt options

• quantifies outcome of each decision

• highlights the likelikhood of each outcome

List three disadvantages of a decision trees

• relies heavily on estimates (probilities n financial outcomes)

• doesn’t take into account qualitative factors

• estimates may be biased

• may not consider external influences (if cost of one option is substantially higher will this be affected by interest rates)

• non dynamic- may be out of date before a decision is reached

What are the influences on decision making?

• Mission: does decision fit in w bus. overall purpose

• Objectives: will the decision help the bus. achieve goals within specific time period

• Ethics: decision morally right, managers comfortable w the decision, does it meet their own ethical standards

• External environment: competition- how will changes in the ee (fluctuating economy/competitors actions) influence financial outcomes n probabilities? will this have a big impact on decision making?

• Resource constraints: even if a decision looks like the right one is it achievable w the resources available like…

  • time

  • human resources

  • expertise

  • finance

Define probability

Chance of an outcome happening

Define expected value

the financial value of an outcome calculated by multiplying the estimated financial effect by its probability ((success probability x success no.) + (failure probability x failure no.))

Define net gain

Value to be gained from taking a decision. Calculated by adding expected value of each outcome and deducting the costs associated with the decision (expected value - buylocal//import)

What’s meant by a quantitative approach to decision making?

to make decisions using mathematical and statistical models in situations when the probability of all outcomes is uncertain

What is the formula for expected value?

Financial value x probability for each chance added together

State three situations where a business might make use of a decision tree

downsizing

outsourcing critical functions

expanding into new markets