Decision Tree

Constructing a decision tree

 Goals
Students will be able to:

● Explain the requirements for the IA in terms of structure.

● Construct a decision tree.
● You will understand that changing and complex business
environments can become clear when using a decision tree.
Decision
Tree
Decision trees
EMV Net gain
$0.8m

$0.74m $0.74m - $0.2m = $0.54m

-$0.06m

$2.4m
$1.6m - $1m = $0.6m
$1.6m

-$0.8m
Decision trees - explanations
The square These are the estimated
highlights that a expenses if this course of
decision has to action is chosen.
be made
square =
decision nodes The financial result/revenue
if the course of action
succeeds or fails.

The probability of success or

failure.
60% = 0.6
40% = 0.4

The estimation of different course of

The lines are actions; circle = chance nodes
different options
Decision trees - explanations
What would be the EMV and the net
gain?

EMV = (probability 1 x expected outcome 1)

+ (probability 2 x expected outcome 2) , etc.

For Modify existing product :

EMV = (0.8x$1m) + (0.2 x -$0.3m)

= $0.8 m - $0.06m = $0.794m

Net gain = EMV of all outcomes - initial cost

For Modify existing product :

Net gain = $0.794m - $0.2m

= $0.594m
Case study: British Nelson
Let’s read about the company we’ll work on.

British Nelson is an oil-producing company. There are two parts to the business, searching for new oil
fields and oil extraction. The company currently has low retained profits as they have recently paid a
huge fine to the USA government.

Draw a decision tree, then, answer the question;

Where should they look for a new oil field?

1. Read the given information and based on it construct a complex decision tree with 4 decision nodes.

2. Based on your calculations of EMV and net gain, answer the question above.
Case study: British Nelson
Where should they look for a new oil field?

1. Read the given information and based on it construct a complex decision tree with 4 decision nodes.

2. Based on your calculations of EMV and net gain, answer the question above.

1. Make sure you have enough space around the chance nodes and decision nodes as there is a lot of
information you need to squeeze in there.
2. Make sure that your decision tree is concise and it could be easily understood. Think of the most logical
space to put your calculations (EMV and net gain).
3. When you find the net gain for selling and developing the fields, you need to start eliminating the
options (whether developing or selling is best). Then go back to the success or fail of finding an oil field in
the particular region where you should again find the net gain which is the one you will consider at the
end.
Case study: British Nelson C he ckin
g

1. Check if you have constructed correctly the decision tree by taking a look at the answer key.

2. Reflect on your understanding of constructing complex decision trees by answering the

questions:
● Do I feel confident to construct a decision tree?
● To what extent did I achieve our second goal ‘To be able to construct a decision tree’?
● Are there any questions left unanswered?
Case study: British Nelson

1. Based on your personal experience of constructing a decision tree, elicit possible advantages
and disadvantages of using a decision tree.

Be prepared to share your findings with the rest of the groups.

A decision tree: Advantages and Disadvantages
Advantages
1. It offers a visual representation of different
decisions and choices, with probable and
quantifiable outcomes. This makes decision
making more informed, objective, and logical.
2. It helps managers to consider the various
financial risks involved with different choices
options, not just the potential financial rewards.
3. The results are easy to understand, with
quantitative results to support decision making.
4. Flexible tool as it could be applied for different
situations and decisions.
Disadvantages
1. It ignores qualitative factors (non-financial
information) that often affect decision making.
2. The probabilities are only forecasts even if
based on market research data. This means the
predicted outcomes are still unknown.
3. Changes in the external business
environment can easily change the probably
outcomes.
4. For very complex decisions, it can be difficult
to construct a decision tree diagram that is
concise.
Case study: British Nelson Plen
ary

Take a look at the questions on the board and answer them within your group:

1. How can a decision tree be used to identify appropriate growth strategies?

2. To what extent is it possible to plan for change?

Be prepared to share your thoughts with the rest of the groups.

 Goals
To what extent did we achieve the goals?

Students will be able to:

● Reflect on your last exam and set goals for improving your work.
● Construct a decision tree.
● Explain the requirements for the IA in terms of structure.