3.3.3 - decision trees

What is a decision tree?

A quantitative decision‑making tool that compares options using probabilities and financial outcomes.

how does a decision tree work

A decision tree works by breaking a decision into choices, outcomes, probabilities, and financial consequences, allowing a business to choose the option with the highest expected net gain.

example

• after you times each number by the decimal

• then find the sum of them

• then you will see which is more profitable

advantages of decision trees

• Provide a clear, visual structure for comparing options.

• Force managers to consider risk by attaching probabilities.

• Encourage logical, evidence‑based decision‑making rather than intuition.

• Quantify outcomes, making decisions more objective.

• Useful when decisions involve financial consequences and uncertainty.

• Help justify decisions to stakeholders with numerical backing.

• Allow comparison of multiple options at once.

• Highlight the most profitable option through EMV and net gain.

• Make assumptions explicit, improving transparency.

• Can be combined with qualitative judgement for a balanced decision.

limitation of decision trees

• Financial outcomes are forecasts, so results can be inaccurate if conditions change.

• Creates a false sense of certainty because numbers appear precise

• Does not account for external shocks (competitors, economic changes).

• Time‑consuming to construct for major strategic decisions.