Decision Tree

Choice of the Best Alternative

Syndicate 2
Dina Rizkia Rachmah (29120431)
Muhammad Ikhlas Dharma (29120398)
Desman Hansen Sagala (29120481)
 01 02
Table Of Contents
Exercise 1 Exercise 2
Alternatives without probabilities Alternatives with probabilities

03 04
Case Conclusion
Case on food processing
Conclusion of the case
industry company

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 Exercise 1
01 Alternatives without probabilities

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 Exercise 1
You are given the following payoff table (in units of thousands dollars)
for a decision analysis problem without probabilities.

State of Nature Payoffs

Alternatives Max in Min in
State 1 State 2 State 3
Row Row
A1 4 2 8 8 2
A2 3 1 3 3 1
A3 4 6 5 6 4
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 Questions & Answers

1. Which alternative should be chosen under the maximax criterion?

→ The maximum of maximum would be 8. Hence, the answer would be

Alternative 1 (A1).

2. Which alternative should be chosen under the maximin criterion?

→ The maximum of minimum would be 1. Hence, the answer would be

Alternative 2 (A2).

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 Exercise 2
02 Alternatives with probabilities

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 Exercise 2
You are given the following payoff table (in units of thousands dollars)
for a decision analysis problem.

State of Nature Payoffs

Alternatives
Max in Min in EV
State 1 State 2 State 3
Row Row
A1 150 110 170 170 110 150
A2 180 200 220 220 180 210
Prior Probability 0.1 0.3 0.6

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 Questions & Answers

1. Which alternative should be chosen under the maximax criterion?

→ The maximum of maximum would be 220. Hence, the answer would be
Alternative 2 (A2).
2. Which alternative should be chosen under the maximin criterion?
→ The maximum of minimum would be 110. Hence, the answer would be
Alternative 1 (A1).
3. Which alternative should be chosen under the maximum likelihood criterion?
→ The highest probability is 0.6 for State 3, and 220 is a higher number
compared to 170. Hence, the answer would be Alternative 2 (A2) for State 3.
4. Which alternative should be chosen under the Bayes’ Decision Rule?
→ The highest expected value (EV) is 210. Hence, the answer would be
Alternative 2 (A2).

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Bayes’ Decision Rule

State of Nature Payoffs

Alternatives EV
Max in Min in
State 1 State 2 State 3
Row Row

A1 150 110 170 170 110 150

A2 180 200 220 220 180 210

Prior Probability 0.1 0.3 0.6

Bayes’ Decision Rule choose best alternative by considering entire information that being
owned by doing steps mentioned:

Calculate Expected Value for every decision alternative

EV = S(prior prob x payoff)

Choose the decision alternative that has the largest Expected Value

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 Questions & Answers (cont.)
5. Construct a decision tree by hand for this problem. 1. Decision: A1or A2
2. SON : State 1, State 2, State 3
3. Event Nodes
State 1 150 (0,1) 4. Payoff
A1 State 2 110 (0,3) EV(A1) = Sigma p(Event) * Payoff
= (0.1)*(150) + (0.3)*(110) + (0.6)*(170)
150 = 150 Expected Payoff :
State 3 170 (0,6)
= Max{EV(A1),EV(A2)}
= Max{150,210} = 210
210 State 1 180 (0,1)

EV(A2) = Sigma p(Event) * Payoff Action : Alternative A2 !

A2 State 2 200 (0,3)
= (0.1)*(180) + (0.3)*(200) + (0.6)*(220)
210 State 3 220 (0,6) = 210

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 Exercise 3
03 Alternatives without probabilities

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 An engineer who works at company of equipment for the food
processing industry has been asked to consider the
development of a new type of processor.

Case: • There are two alternative power sources could be used for the
processor, namely gas and electricity,
•There are technical reasons each power source would require

Intro
a fundamentally different design.
•Resource constraints mean that the company will only be able
to pursue one of the designs, and because the processor would
be more advanced than others which have been developed it is
by no means certain that either design would be a success.

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 The engineer estimates that there is a 75%
chance that the electricity-powered design

Case:
would be successful.
1. If success will get profit $10 M and
2. If fail then it loses $3M

Only a 60% chance that the gas-powered design

would be a success. Estimation
1. If success will get profit $15 M and
2. If fail then it loses $7M

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● After considering this tree the engineer realizes that if either
design failed then the company would still consider
modifying the design, though this would involve more
investment and would still not guarantee success.
● He estimates that the probability that the electrical design
could be successfully modified is only 30%.
1.If success will get profit $6 M and
2.If fail then it loses $7M
Case: Cont.
● The probability of the gas design would have an 80%
chance of being modified successfully.
1.If success will get profit $10 M and
2.If fail then it loses $12M

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 Case: Questions

Build the complete decision tree

1. What are the alternatives (Decision node)?

2. What are the SON (Events node)?
3. What are the payoff/outcome?
4. Calculate the Expected Value?
5. What is the optimal path?

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 3rd Case

$6,75M E1,1 success $10M (0,75)

O1,1
-$3,1M E3,1 success $6M (0,3) O3,1
D1,1
D2,1
Fail -$3M (0,25)
E1,2 D2 E3,2 Fail -$7M (0,7)
D1 O1,2 O3,2
D2,2
-$3M

$11,8M E2,1 Success $15M (0,6)

O2,1
$5,6M E4,1 success $10M (0,8) O4,1
D1,2
D3,1
Fail -$7M (0,4)
D3 E4,2 Fail -$12M (0,2)
E2,2 O2,2 O4,2
D3,2 -$7M
D1,3
$0M

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 Answer of 3rd Case
1. Alternatives:
D1,1: Develop electric-powered design.
D1,2: Develop gas-powered design.
D1,3: Do not develop the product.
D2,1: Consider modify design of D1,1 failure
D2,2: Abandoned modify
D3,1: Consider modify design of D1,2 failure
D3,1: Abandoned modify

2. SON:
E1,1 success of D1,1 E3,1 success of D2,1
E1,2 fail of D1,1 E3,1 fail of D2,1
E2,1 success of D1,2 E4,1 success of D3,1
E2,2 fail of D1,2 E4,2 fail of D3,1

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 Answer of 3rd Case
3. Payoff/outcome
O1,1 O1,2 O2,1 O2,2 O3,1 O3,2 O4,1 O4,2

4. EV D1,1: [(0,75 x 10)+(0,25 x -3)]= $6,75M

EV D1,2: [(0,6 x 15)+(0,4 x -7)]+[(0,8 x 10)+(0,2 x 12)]= $6,2M +$5,6M= 11,8M
EV D1,3: $0M
EV D2,1: [(0,3 x 10)+(0,7 x 7)]= -$3,1M
EV D2,2: -$3M
EV D3,1: [(0,8 x 10)+(0,2 x 12)]= $5,6M
EV D3,2: -$7m

5. The optimal path is D1,2 because got the highest result. It happened by the
success of E2,1 plus the success of E4,1.

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 Conclusion
04 D1,2 is the best path because it
generated the best result. It happened
as a result of the success of E2,1
combined with the success of E4,1.

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 Thanks!
Do you have any questions?

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