Decision Trees

Question 1

What is the primary purpose of a decision tree?

Answer 1

To display and evaluate a series of decisions based on earlier outcomes

It helps management consider all options and possible outcomes.

Question 2

When should a decision tree be used?

Answer 2

When considering a course of action with further decisions or a range of possible outcomes

Not all decisions require a decision tree.

Question 3

What are the three types of events in a decision tree?

Answer 3

• Decision point
• Outcome point
• End point

Each type of event has a distinct role in the decision-making process.

Question 4

What is the cost of commissioning a survey for Site A?

Answer 4

£250,000

This cost is incurred to establish the extent of renovation work needed.

Question 5

What are the probabilities associated with the renovation costs for Site A?

Answer 5

• 60% chance of £35m
• 40% chance of £28m

These probabilities help in evaluating the expected costs of renovation.

Question 6

What is the estimated selling price of Site A if sold to a property developer?

Answer 6

£15m

This amount can be used towards the acquisition of Site T.

Question 7

What is the potential selling price of Site A if planning permission is granted?

Answer 7

£32m

If planning permission is denied, the offer would drop to £13m.

Question 8

What is the cost of applying for planning permission for Site A?

Answer 8

£750,000

This cost is incurred regardless of the outcome of the application.

Question 9

What is the expected value of the renovation costs if STVS commissions the survey?

Answer 9

£32.2m

This value is calculated based on the probabilities of renovation costs.

Question 10

What is the expected sales proceeds if STVS applies for planning permission?

Answer 10

£29.15m

This value is derived from the probabilities of selling prices based on planning permission outcomes.

Question 11

What are the net borrowings if STVS sells Site A without planning permission?

Answer 11

£45m

This is calculated as £60m (cost of Site T) minus £15m (proceeds from Site A).

Question 12

What are the advantages of using decision trees?

Answer 12

• Easy to follow
• Useful summary of complex scenarios
• Allows consideration of combinations of options

Decision trees help in visualizing and evaluating multiple outcomes.

Question 13

What are the disadvantages of using decision trees?

Answer 13

• Expected values are averages
• Probabilities may be unreliable
• Nonfinancial factors are not included

These limitations can affect the decision-making process.

Question 14

What is the cost of the basic package for the summer fair?

Answer 14

£1,200

This package accommodates a limited number of people.

Question 15

What is the expected revenue from the deluxe package at the summer fair?

Answer 15

£5,300

This is calculated based on attendance probabilities.

Question 16

What is the accuracy rate of the survey company for attendance predictions?

Answer 16

85%

This indicates the reliability of the survey’s predictions.

Question 17

What are the two types of information in decision-making?

Answer 17

• Perfect information
• Imperfect information

Perfect information is always correct, while imperfect information has a known reliability.

Question 18

What is the expected revenue at Point A if the survey is positive and STVS decides to rent the deluxe package?

Answer 18

£6,015

Calculated as ((0.85 × 6600) + (0.15 × 2700)).

Question 19

What is the expected value of revenue at Point B if STVS ignores the positive survey and opts for the basic package?

Answer 19

£2,700

This is the revenue expected from the basic package.

Question 20

If the survey returns positive feedback, what is the net expected cash flow at Point C if STVS chooses the deluxe package?

Answer 20

£3,815

This is calculated as (£6,015 − £2,200).

Question 21

What is the expected revenue at Point D if the survey is negative but STVS decides to rent the deluxe package?

Answer 21

£3,285

This reflects the revenue expected from the deluxe package under negative survey conditions.

Question 22

What is the expected revenue at Point E if the survey is negative and STVS decides to rent the basic package?

Answer 22

£2,700

This is the revenue expected from the basic package under negative survey conditions.

Question 23

At Point F, what is the net expected cash flow if STVS chooses the deluxe package after a negative survey?

Answer 23

£1,085

This is calculated as (£3,285 − £2,200).

Question 24

What is the expected net revenue at Point G if the survey is commissioned?

Answer 24

£3,236

This is calculated as ((0.75 × £3,815) + (0.25 × £1,500)).

Question 25

What are the expected cash flows if the survey is commissioned compared to making a decision without the survey?

Answer 25

* With survey: £3,236 * Without survey: £3,100 ## Footnote The survey increases expected net cash flows by £136.

Question 26

True or false: The survey has increased the expected net cash flows by **£136**.

Answer 26

TRUE ## Footnote If the survey costs more than £136, the cost would wipe out the benefit.

Question 27

What is recommended regarding the use of **decision trees** in the overall decision-making process?

Answer 27

They should form only a small part of the overall decision-making process ## Footnote This is due to drawbacks in estimating values of outcomes and probabilities.