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Version 3.4 10/27/2007 Constructing a Decision Tree with Built-in Formulas Johnson Graduate School of Management Cornell University Ithaca NY 14853

This spreadsheet is intended for teaching purposes. You are welcome to use it in any manner, and change it as you see fit. This model comes without any guarantee whatsoever, and is distributed free of charge. A Decision Tree represents a series of decisions that are linked through time. That is, after one decision has been made, there may be any number of subsequent decisions. Moreover, the choices that are available for future decisions depend on past choices. A diagram is very helpful in keeping track of all of these details, and explaining the situation to others. The diagram below illustrates the three types of Nodes on a Decision Tree: Decision Nodes (Yellow), Probability Nodes (Blue) and Terminal Nodes (Gray). Node 1 is a Decision Node, which means that you may choose among the outgoing branches. The first choice would lead you to Node 2, where the payoff is 20. The second choice goes to Node 3, payoff 10. The third goes to Node 4, where the payoff is 10.4. (Explanation of this number is given below.) The word Yes appears on the first branch because it has the highest payoff. The word No appears on the other branches because their payoffs are lower. The number 20 appears in Node 1 because that is what you get if you follow the best branch.
Now Node 1 20 Yes No No Change Model Node 2 20 Node 3 10 Node 4 10.4 0.4 Node 5 -34 0.6 Node 6 40 Future

Nodes 2, 3, 5 and 6 are Terminal Nodes. Nothing follows from them. Each terminal node has a payoff, and you (the decision maker) have to enter these values. Node 4 is a Probability Node, which means that you CANNOT choose among the outgoing branches. Only one of the branches out of Node 4 will happen, and that is a matter of chance. The probability of the first branch is 0.4 (or 40%) and if it happens you will go to Node 5 and get a payoff of -34. (That is, you will lose 34.) The probability of the second branch is 0.6, leading to Node 6, payoff 40. You have to supply the probabilities for these branches. They must add to 1.0. The number 10.4 appears in Node 4. That is the Expected Value of the Payoff, which is a weighted average, using the probabilities as weights. In this case, 0.4(-34) + 0.6(40) = 10.4.



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How to Construct a Decision Tree

First, go to the "Tree" worksheet. All work must be done there. Link to Tree Worksheet Changes can be made in two ways: right-click on a cell, or click the "Change Model" button. If you want to delete whatever is currently on the Tree sheet and start a new tree, here is how: Click "Change Model" (or right-click on an empty cell) and choose Erase this Decision Tree and Build a New One If you want to change a branch assignment between two Nodes, right-click on either node. You cannot change a branch in any other way. You must do it from one of the nodes that it connects. You may, however, enter probabilities directly on branches that lead out of Probability Nodes. A Node can be changed or deleted by right-clicking on it. This includes: > Changing its "Type" (Decision, Probability or Terminal) > Changing its "Successors" (a node reached directly through an outgoing branch) > Changing its "Predecessor" (a node reached directly through an incoming branch) (at most one predecessor is possible for each node) > Deleting the node. Please Note: You can't modify the basic design by moving cells around or typing in new formulas. The entire model is re-written every time you use the right-click or the "Change Model" button.

Entering Data on a Decision Tree

There are only three kinds of Data that you enter on the Decision Tree: 1) Names for each Node. Each Node consists of two cells, side-by-side (solid color, with a border around both cells.) The left cell contains the name (see diagram below). You may change any or all names as you see fit. 2) Values for each Terminal Node. The right cell of Terminal nodes represent the payoffs at the end of the decisions. You must enter these values. Warning: DON'T change the right cells of Decision or Probability Nodes. They contain formulas. 3) Probabilities for each branch leading out of a Probability Node. You enter the probabilities. They are located under each branch, in the column that is just to the right of the corresponding Probability Node. Make sure they add up to 1.0 for each Probability Node.
Decision Node

Probability Node

Terminal Node

Now Node 1 20 Yes No No

Change Model Node 2 20 Node 3 10 Node 4 10.4 0.4 Node 5 -34 0.6 Node 6 40





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Now Node 1 20 Yes No No

Future Node 2 20 Node 3 10 Node 4 10.4 0.4 Node 5 -34 0.6 Node 6 40

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Try these steps. If step 1 does not work, then go to step 2. STEP 1: Try to enable the macros
For Excel 2007, A. If you see the Security Warning in your menu bar, proceed with step B. If the Security Warning is not there, go to STEP 2. In the Security Warning, Click Options. B. C. In the Alert Window that appears, click Enable This Content and click OK.

For Excel 2003, A. Close this file. Then open it again. B. In the window that appears, click Enable Macros. If a window like this one does NOT appear, then go to STEP 2.

STEP 2: If Step 1 does not work

If you DID NOT get a Security Message, then your security setting is too high. Here is what you should do: For Excel 2007, A. Click the Microsoft Office Button at the top-left of the screen: B. Click Excel Options. C. Click Trust Center, then Trust Center Settings, and then Macro Settings. D. Click Disable all macros with notification

128301181.xls.ms_office, Warning, p. 5 of 6 E. Exit from Excel. Closing the file is not enough. On the menu bar, select File, and then Exit. F. Open this file again and follow the instructions in STEP 1 to enable the macros. For Excel 2003, A. On the menu bar at the top of this page, select Tools, then Macro, then Security. B. On the Security Level tab, select Medium and click OK. C. Then exit from Excel. Closing the file is not enough. On the menu bar, select File, and then Exit. D. Open this file again and follow the instructions in STEP 1 to enable the macros.

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