Decision Trees

What is a Decision Tree?

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

How does it work?

• A decision tree uses estimates and probabilities to calculate likely outcomes

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

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

Final thoughts on 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