Decision Trees

Question 1

What is a decision tree

Answer 1

A mathematical model used to help make decisions.
It uses estimates and probabilities to calculate likely outcomes
Helps decide whether the net gain for decision is worthwhile

Question 2

What is probability

Answer 2

Chance of an outcome happening

Question 3

What is expected value

Answer 3

Financial value of a outcome calculated by multiplying the estimated financial effect by its probability

Question 4

What is net gain

Answer 4

Value to be gained from taking a decision which is calculated by adding together the expected value of of each outcome and deducting the costs associated with the decision

Question 5

How to calculate the net gain

Answer 5

Expected value of a choice - initial costs

Question 6

What does the business do if there’s a high net gain

Answer 6

They should pick it up

Question 7

What are the advantages of a decision tree

Answer 7

Quick method of weighing up options
Use of probabilities enable the risk of the options to be addressed
Costs and benefits considered
Easy to understand as there is tangible results

Question 8

What are the disadvantages of decision tree

Answer 8

Probabilities are prone to bias
Ignores qualitative aspects of decisions
Doesn’t necessarily reduce the amount of risk