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Decision Trees

Copyright 2006 Biz/ed

http://www.bized.co.uk

Decision Trees

Copyright 2006 Biz/ed

http://www.bized.co.uk

Planning Tool

Copyright 2006 Biz/ed

http://www.bized.co.uk

Decision Trees
Enable a business to quantify
decision making
Useful when the outcomes are
uncertain
Places a numerical value on likely
or potential outcomes
Allows comparison of different
possible decisions to be made
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http://www.bized.co.uk

Decision Trees
Limitations:
How accurate is the data used
in the construction of the tree?
How reliable are the estimates
of the probabilities?
Data may be historical does this data
relate to real time?
Necessity of factoring in the qualitative
factors human resources, motivation,
reaction, relations with suppliers and other
stakeholders
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http://www.bized.co.uk

Process

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The Process
Economic growth rises
0.7

Expected outcome
300,000

Expand by opening new outlet

Economic growth declines
0.3

Expected outcome
-500,000

Maintain current status

0
The circle denotes the point where different outcomes could occur. The estimates of the probability and the
knowledge of the expected outcome allow the firm to make a calculation of the likely return. In this
A square
example
it is: denotes the point where a decision is made, In this example, a business is contemplating
There
is also
the outlet.
option The
to douncertainty
nothing and
current
status quo!
wouldcontinues
have an outcome
opening
a new
is maintain
the state the
of the
economy
if theThis
economy
to grow of
0.
Economic
growth
rises: is
0.7
x 300,000
= 210,000
healthily
the option
estimated
to yield
profits of 300,000. However, if the economy fails to grow as
expected, the potential loss is estimated at 500,000.
Economic growth declines: 0.3 x 500,000 = -150,000
The calculation would suggest it is wise to go ahead with the decision ( a net benefit figure of +60,000)

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The Process
Economic growth rises
0.5

Expected outcome
300,000

Expand by opening new outlet

Economic growth declines
0.5

Expected outcome
-500,000

Maintain current status

0

Look what happens however if the probabilities change. If the firm is unsure of the potential for growth, it
might estimate it at 50:50. In this case the outcomes will be:
Economic growth rises: 0.5 x 300,000 = 150,000
Economic growth declines: 0.5 x -500,000 = -250,000
In this instance, the net benefit is -100,000 the decision looks less favourable!

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Advantages

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Disadvantages

Copyright 2006 Biz/ed