Decision Trees

Question 1

What are decision trees used for?

Answer 1

To aid decision making process, show likely financial return for each option, consider risk in relation to possible reward.

Question 2

What does each bit of the decision tree diagram mean? (Square, circle, //)

Answer 2

Square = decision.
Circle = possible outcomes.
// = if decision is made to sell, other option must come to an end.

Question 3

What’s the process of using decision trees?

Answer 3

1. Add probabilities to outcome.
2. Add estimated monetary value (EMV).
3. Calculate expected value (EMV x probability).
4. Add expected values (put into outcome box).
5. Take away costs.
6. Put highest into decision box.
7. Always add ‘NOTHING’ outcome.

Question 4

What are the advantages and disadvantages of decision trees?

Answer 4

Advantages:
- simplistic, visual aid.
- quick and cost effective.
- attempts to account for risk, unlike other decision techniques.

Disadvantages:
- no mention of time period.
- dependent on accuracy of figures used.
- qualitative evidence not considered.