Decision trees Flashcards
What is a decision tree
It’s a tool that helps managers predict what might happen if they make a certain decision.
What can decision trees be used to show
The choices to be made (take option a or be etc)
The financial cost of each option.
Possible outcomes following the choice that is made.
The probability of each outcomes occurring (attach a probability to the choice)
The estimated financial result of each outcome.
The estimated value of each decision.
The net gain to be earned from the choice
Ways to identify negatives
Any negative numbers may not have the (-) symbol, and if they are if the number is a negative, but they haven’t put a negative around it, they will put brackets around it. For example (50,000) would mean -50,000
How to make a decision tree
First the decision tree start on the left with a square - The net gain will be put inside of this
You take your first option and identify the costs - The circle that you put represents the choice - You put the expected value in there
You then insert the chance of success - and how much that would net
Then you insert the chance of failure o and how much that would cost
You do this for each decision
You then work from right to left to workout the net gain
You divide that chance of success by its value - You do the same for failure - Make sure you insert the (-) in the calculator for the failure
You then add the 2 figures you get together - Then insert that figure in the circle that represents expected value
You do the same process for the other decision
To calculate the net gain, you take the expected value from the costs - which will give you the net gain of that decisions
Obviously the best decision (usually measured by profit) is the best option to go for
https://www.youtube.com/watch?v=B3cEr4NTShM&list=PL12ABlJJFqkvty9sPTsNx1Ob8vrFU9ban&index=9
What are the pros
Encourages a logical approach to decision making
Gives each option financial value, making them easy to compare
