Decision Trees Flashcards
what is a decision tree?
visual tool used by managers to see possible options and the probable outcomes of each option to support informed decision making.
why are decision trees a valuable tool?
shows different outcomes that might occur
shows costs and revenues associated with an outcome
shows probability of an outcome occurring
what is a Decision Node?
square represents a decision that needs to be made
what is a Rejected Option?
Rejected options are when you reject the lower number because its the one that will make you less income. they are two diagonal lines
what is a Chance Node?
circle represents the probable outcomes of different decisions.
What is a probability? and how can they be shown?
are shown as decimal numbers, e.g., 0.65 means a 65% chance of the outcome occurring.
how can you reject an option?
by drawing two parallel lines on their branch
how is the probable outcome calculated?
Probability (ex. 0.6 or 0.5) x Expected Revenue
How do you calculate the expected value?
Probable outcome - Cost of option
When creating a decision tree what do you always have to do?
Make a key that shows what the circle, square, and parallel lines represent.
Advantages of Decision trees
- offer managers visual representation of outcomes with probable and quantifiable outcomes 2. helps consider the financial risks that each option involves 3. they’re easy to understand and have quantitative results 4. flexible organizational planning tool can adapt to different situations
Disadvantages of Decision trees
- purely quantitative planning tool, decision trees ignore qualitative factors (non financial info) 2. probabilities are only forecasts 3. use of decision trees does not necessarily reduce the amount of risks 4. for complex decisions it might be difficult to construct a decision tree that’s short and concise
