Decision Trees Exercise

1. If Mr Diner is considering expanding operations then he may have to decide between

launching a new advertising campaign or continuing with the existing one. The costs
associated with these alternatives are:

Market research information suggests that there is a 60% chance that the new
advertising campaign will be successful and a 50% chance that if the old campaign is
retained, it will be successful.
a) Draw a decision tree of the options faced by Mr Diner. [7 marks]
b) State which alternative the firm should choose, and give ONE reason for your
answer. [2 marks]
c) State TWO advantages and ONE disadvantage of using decision trees.
[3 marks]

2. John, the Production Manager of Carib Incorporated, has an option of locating his
firm's production plant in Moonlight Island or Sunny Isle. He is provided with the
following data on both countries.

a) Draw a Decision Tree to illustrate the above scenario. [ 9 marks]

a) Calculate the expected value for:
(i) Moonlight Island
(ii) Sunny Isle [4 marks]
b) Recommend to John, the country in which he should locate the production plant,
and why. [ 2 marks]
3. Hilton Barbados must decide whether to expand the hotel, renovate the existing
structure, or build a second facility. The returns of each alternative depends however on the
state of the economy at the time of completion. The economy is predicted to either grow by
1%, grow by 2% or contract by 1.1%. the cost of each alternative along with the various
returns under each under each scenario are given below.
Alternative Cost Growth of 1% Growth of 2% Recession of
(0.6 chance) (0.1% chance) 1.1% (0.3
chance)
Expand hotel $650,000 $1,200,000 $4,000,000 $800,000
Ronovate $250,000 $400,000 $600,000 $300,000
hotel
Build second $3,000,000 $4,000,000 $6,000,000 $1,000,000
facility

a) Draw the decision tree to show this information. [7

marks]
b) Calculate the expected values for each option and determine on financial
grounds which option the farmer should select. [2
marks]
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