Transcript ###Decision Trees - PowerPoint Presentation

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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
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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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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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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 example
it is: A square 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
Economic
£0.
growth
rises:
0.7
x
£300,000
=
£210,000
healthily the option is estimated to yield profits of £300,000. However, if the economy fails to grow as
expected,
the declines:
potential 0.3
lossxis£500,000
estimated
£500,000.
Economic
growth
= at
-£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
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