Decision trees

Minne Li
Outline
ØThefollowing planning tool in a given situations (AO2,
AO4)
• Decision tree

ØThevalue to an organization of these planning tools

(AO3)
Decision trees
• Option 1: sell the property at the current market price
of $600,000 this year. This option would incur costs of
$10,000 for estate agency and solicitor’s fees.
• Option 2: sell the property next year
- 65% chance of receiving a higher price $638,000 after
associated costs
- 25% chance of house price remaining stable; costs
remain the same
- 10% chance of the price declining; the estimated price
is $530,000 after associated costs
Decision trees
Decision tree
• The diagram is constructed from left to right.
• Decision nodes are shown as squares.
• Chance nodes are shown as circles.
• For each chance node, there will be two or more routes
(outcomes) – show the probability of the different outcomes
for each chance node. The probability of each chance node
must add up to 1.
• The actual values of each outcome are stated at the end of
each branch.
• Each unwanted branch of the decision tree is cut-off, indicated
by two parallel lines.
• Keys to indicate all symbols
• Identify the best option
Decision tree
• TCL is considering expanding into one of three locations.
The expected costs and revenues are shown in Table 1.
TCL only has the resources to pursue one of these
options. Construct a decision tree diagram for TCL (show
all your working)

Location Cost ($m) Probability (%) Revenue ($m)

choice
High sales Low sales High sales Low sales
Shanghai 95 60 40 220 85
Beijing 85 50 50 200 75
Guangzhou 100 65 35 190 90
Decision tree
• CMB manufactures bicycles in a large factory. Government data
suggest that there is a 45% chance of the economy improving during
the next three years, with a 35% chance of it remaining unchanged
and only a 20% chance of the economy worsening. Hence, CMB is
considering three growth option:
• Option 1: launch a new line of foldable bikes, costing an estimated
$2.5m
• Option 2: build a new factory to increase the productive capacity of
its existing bikes, costing an estimated $4.5m.
• Option 3: diversify by building skateboards to add to its current
product portfolio, costing an estimated $1.5m
• Construct a decision tree diagram for CMB.
State of Option 1 Option 2 Option 3
economy ($m) ($m) ($m)
Improves 5 8 3
Unchanged 3 5 2
Worsens 2 3 -1
Decision tree
Decision trees
Advantages Disadvantages
They allows managers to set out The probabilities given in a decision
problems in a clear and logical manner. tree are only estimates and subject to
All potential options can be seen at the forecasting errors.
same time, thereby speeding up
decision-making.
They consider the risks involved in Delays in the planning process can
decision-making, such as possible void the data by the time a decision is
negative outcomes. actually made, yet time lags are often
They enable more scientific and inevitable in the real business world.
objective decisions to be made as all
likely costs of decisions are
considered.
They are based on quantitative data
only, so qualitative issues are ignored.