3.3.3 decision trees

Question 1

what is a decision tree

Answer 1

a mathematical model
used to help managers make decisions
uses estimates and probabilities to calculate likely outcomes.
helps to decide whether the net gain from a decision is worthwhile.

Question 2

uses of decision trees

Answer 2

analyses the probability of a success in a choice of strategies

Question 3

constructing a decision tree

Answer 3

square (decision to be made)
choice / option 1,2,3
add circles ( represent uncertain outcomes )
add in associated costs, outcome probabilities and financial results for each outcome

Question 4

define probability

Answer 4

percentage chance or possibility that an event will occur
ranges between 1 ( 100% ) and 0
if all outcomes of an event are considered, total probability must add up to 1

Question 5

expected value

Answer 5

financial value of an outcome calculated by multiplying the estimated financial effect by its probability

Question 6

net gain

Answer 6

value to be gained from taking a decision.
calculated by adding together the expected value of each outcome and deducting the costs associated with the decision

Question 7

advantages of using decision trees

Answer 7

choices are set out in a logical way.
potential option and choices are considered at the same time.
use of probabilities enables the risk of the options to be addressed.
likely costs are considered as well as potential benefits.
easy to understand

Question 8

disadvantages of decision trees

Answer 8

doesnt take into account unforeseen costs and circumstances.
not useful when a business needs to act quickly.
degree of usefulness varies with the context of the business