Decision Trees in Business

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Decision Tree

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A quantitative decision-making tool that helps businesses choose between different options when outcomes are uncertain.

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Uses of Decision Trees

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- Probabilities of different outcomes - Estimated financial returns - A visual diagram to map out decisions and consequences

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Diagram Symbols

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- A square represents a decision to be made. - Lines from the square represent possible choices. - Circles show outcomes as a result of a choice.

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Outcome Probabilities

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The probability of all outcomes must add up to 1.

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Expected Value (EV)

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Shows the weighted average of a given choice. Calculated by multiplying the probability of each outcome by its expected value and adding them together.

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Expected Value Example

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EV Launch new product = 0.4 \times 30 + 0.6 \times -8 = £7.2m

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Expected Value Definition

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The average outcome if a decision is made many times.

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Decision tree diagram

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Visual representation of decision-making process with probabilities and financial outcomes.

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Net Gain definition

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The Net Gain is the Expected Value minus the initial cost of a given choice. It is the profit or benefit expected after costs have been taken into account.

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Net Gain of launching a new product

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Net Gain of launching a new product = £7.2m - £5m = £2.2m.