Operations Management For Competitive Advantage ninth edition 1

Decision Trees
 Used for complex decision problems
 characterized by uncertainities
 Two main symbols:
 Box = Decision
 Circle = Random event
 Expected profit values calculated
 Select decision with highest exp. profit

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Operations Management For Competitive Advantage ninth edition 2

An Example
A glass factory specializing in crystal is experiencing a
substantial backlog, and the firm's management is considering
three courses of action:

A) Arrange for subcontracting,

B) Construct new facilities.
C) Do nothing (no change)

The correct choice depends largely upon demand, which may

be low, medium, or high. By consensus, management
estimates the respective demand probabilities as .10, .50,
and .40.

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Operations Management For Competitive Advantage ninth edition 3

The Payoff Table

The management also estimates the profits when
choosing from the three alternatives (A, B, and C) under
the differing probable levels of demand. These costs, in
thousands of dollars are presented in the table below:

0.1 0.5 0.4

Low Medium High
A 10 50 90
B -120 25 200
C 20 40 60

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Step 1: Draw the decisions

A
B

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Step 2: Draw the random events

High demand (.4) $90k
Medium demand (.5) $50k
Low demand (.1) $10k

A High demand (.4) $200k

B Medium demand (.5) $25k
Low demand (.1) -$120k
C
High demand (.4) $60k
Medium demand (.5) $40k
Low demand (.1) $20k

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Step 3: Calculate exp. values

High demand (.4) $90k
Medium demand (.5) $50k
$62k Low demand (.1) $10k

EVA=.4(90)+.5(50)+.1(10)=$62k

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Operations Management For Competitive Advantage ninth edition 7

Step 4: Select best alternative

High demand (.4) $90k
Medium demand (.5) $50k
$62k Low demand (.1) $10k

A High demand (.4) $200k

$80.5k
B Medium demand (.5) $25k
Low demand (.1) -$120k
C
High demand (.4) $60k
$46k Medium demand (.5) $40k
Low demand (.1) $20k
Alternative B generates the greatest expected profit, so our
choice is B or to construct a new facility.
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Operations Management For Competitive Advantage ninth edition 8

Other views and criteria

 Sensitivity analysis for the estimated
probabilities
 Can we “buy” better information? EVPI
 Risk Aversion, Utilities

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