1: Decision Trees Flashcards
What does a square point represent in decision tree analysis?
A control point
What does a circular point represent in decision tree analysis?
An uncertainty point (calculation)
What numerical value is calculated in decision trees?
‘Expectation’
How is the total cost of a decision branch calculated in the forward pass?
All the costs associated to each decision added up and totalled
How can the branches be checked to make sure they are right?
All the probabilities of the branches should add up to 1.0
How is ‘expectation’ calculated for the backwards pass?
(p1 x £) + (p2 x £) + (p3 x £) ….
How is the investment decision justified?
Identify the option with the highest ‘expectation’ and then comment on whether the probability of profitable outcomes supports this
What is the probability of profitable outcomes?
The total probability of all profitable outcomes
What two profits should you calculate?
Net and Gross profit
What is net profit?
Net profit is ‘all profit
What is gross profit?
Gross profit is profit compared to expenditure
When the decision tree is complete, how do you recommend an investment?
- Comment on the least cost risk/expectation option
- Comment on whether the probability of a profitable result supports this
- Make the recommendation
What are the advantages of a decision tree?
- Quick and easy to carry out
- Allows decisions to be made based upon ‘expectation’ and probability
- Less financial risk
What are the disadvantages of a decision tree?
- They only consider a basic financial case and not PESTLE factors.
- Uses quantitive data only, ignores qualitative aspects of decision making.
- Other factors, such as running costs, are not considered.
- Assignment of probabilities and expected values are subjective and therefore prone to bias.
What is your profitable outcome?
Any outcome that is more profitable than the alternative investment.
