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# Decision Trees

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Decision Tree

# Scenarios.

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# Go to Work “in the Real World”

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# connect outcomes to their

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node

# Event 3

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# Decision Trees

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# Planning Tool

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# • Allows comparison of different possible decisions to be made

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# Process

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# The Process

Economic growth rises

Expected outcome

• 0.7 £300,000

Expand by opening new outlet

Economic growth declines

Expected outcome

-£500,000
0.3

Maintain current status

£0

 The circle denotes the point where different outcomes could occur. The estimates of the probability and the knowledge of the expected outcome allow the firm to make a calculation of the likely return. In this example A square denotes the point where a decision is made, In this example, a business is contemplating it is: There is also the option to do nothing and maintain the current status quo! This would have an outcome of opening a new outlet. The uncertainty is the state of the economy – if the economy continues to grow Economic growth rises: 0.7 x £300,000 = £210,000 £0. healthily the option is estimated to yield profits of £300,000. However, if the economy fails to grow as expected, the potential loss is estimated at £500,000. Economic growth declines: 0.3 x £500,000 = -£150,000 The calculation would suggest it is wise to go ahead with the decision ( a net ‘benefit’ figure of +£60,000)

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# The Process

Economic growth rises

Expected outcome

• 0.5 £300,000

Expand by opening new outlet

Economic growth declines

Expected outcome

-£500,000
0.5

Maintain current status

£0

Look what happens however if the probabilities change. If the firm is unsure of the potential for growth, it might

estimate it at 50:50. In this case the outcomes will be:

Economic growth rises: 0.5 x £300,000 = £150,000

Economic growth declines: 0.5 x -£500,000 = -£250,000

In this instance, the net benefit is -£100,000 the decision looks less favourable!

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# Draw a decision tree for Joe and tell him what he should do.

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# • Therefore you should not hire the mechanic

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# company, the amount she will receive depends on the market response to her movie. What should she do?

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# P(Large Box Office) = 0.1

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# 0.1

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# Jenny Lind Decision Tree

Small Box Office
Medium Box Office
Large Box Office
Small Box Office
Medium Box Office
Large Box Office
\$200,000
Sign with Movie Co.
\$1,000,000
\$3,000,000
\$900,000
Sign with TV Network
\$900,000
\$900,000

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# Jenny Lind Decision Tree

### ?

Small Box Office
ER
\$200,000
.3
?
Sign with Movie Co.
Medium Box Office
.6
\$1,000,000
.1
Large Box Office
\$3,000,000
Small Box Office
ER
\$900,000
.3
?
Sign with TV Network
Medium Box Office
.6
\$900,000
.1
Large Box Office
\$900,000

# Jenny Lind Decision Tree -

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# Solved

Small Box Office
ER
.3
960,000
Sign with Movie Co.
Medium Box Office
.6
.1
Large Box Office
ER
Sign with TV Network
Small Box Office
.3
Medium Box Office
.6
.1
Large Box Office

### \$900,000

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# Draw a Decision Tree showing these choices.

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# Decision Tree Example

Expand Factory

Cost = \$1.5 M

40 % Chance of a Good Economy

Profit = \$6M

Profit = \$2M

Don’t Expand Factory

Cost = \$0

Good Economy (40%)

Profit = \$3M

Profit = \$1M

# Mary’s Factory –

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