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uk

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Decision Trees Decision Trees

Copyright 2006 Biz/ed

Copyright 2006 Biz/ed

http://www.bized.co.uk

http://www.bized.co.uk

Planning Tool

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
Copyright 2006 Biz/ed Copyright 2006 Biz/ed

http://www.bized.co.uk

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
Copyright 2006 Biz/ed

Process

Copyright 2006 Biz/ed

http://www.bized.co.uk

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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 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 example it is: A square denotes the point where a decision is made, In this example, a business is contemplating There is alsonew outlet. The uncertainty is maintain thethe economy quo! This wouldcontinuesoutcome of opening a the option to do nothing and the state of current status if the economy have an to grow 0. Economic growthoption is estimated to yield profits of 300,000. However, if the economy fails to grow as healthily the rises: 0.7 x 300,000 = 210,000 expected, the potential loss 500,000 = -150,000 Economic growth declines: 0.3 xis estimated at 500,000. The calculation would suggest it is wise to go ahead with the decision ( a net benefit figure of +60,000) Expected outcome -500,000 Maintain current status Expand by opening new outlet

The Process
Economic growth rises 0.5 Expected outcome 300,000

Economic growth declines 0.5

Expected outcome -500,000

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!

Copyright 2006 Biz/ed

Copyright 2006 Biz/ed

http://www.bized.co.uk

http://www.bized.co.uk

Advantages

Disadvantages

Copyright 2006 Biz/ed

Copyright 2006 Biz/ed