What role does a decision tree play in bussiness decision making?
Illustrate the choice between two investment projects with the help of a decision tree assuming hypothical conditions about the state of nature, probability distribution, and corrosponding pay-offs.
In business, a “decision tree” is a type of flow chart for making decisions. A person creates a graph or model of decisions and their possible consequences. The “decision tree” also must include things that might occur by chance or unexpected outcomes, so that proper decisions can be made in these events. The graph includes things like people resources, costs, utility, profits, etc. They can be used in any area of business to analyze decision making, determine business strategies or plan goals. These tools help business strategists to visually conceptualize outcomes. Typically, the parts of the chart contain nodes or boxes that represent decisions, chance outcomes and ends. These nodes are commonly represented by different shapes or colors.
Look at some “decision trees” and then set up the two that you are to compare. There are some good examples at the link below and if you do a search online, you will find others that can serve as models for you as you set up your two trees for the two different investment projects.
A decision tree is a graphical technique to document and evaluate possible outcome of multi-stage decisions taking into consideration probabilities of different outcomes of a decisions taken at any stage. The decisions and their possible outcomes are represented in a diagrams that branches out at each stage of the multi-stage decision. Thus the diagram starts with a single decision which is like the stem of the tree. Different outcomes of this decision with their probability of occurrence are represented as branches emanating from the initial decision. For each of these possible outcomes managers will be required to decide on further course of action. Thus there will be further sub-branches of the decision tree from each of the first level branch. This kind of branching of decisions and their representation on the decision tree can be for several stages.
The representation of decision tree in this way enables managers to identify all the possible outcome in a multilevel decision situation, and evaluate the impact or attractiveness of each possible final outcome along with the probability of its occurrence. This enables managers to choose alternatives that is likely to give best results.
For example, a company considering expansion in manufacturing capacity can consider several alternative in terms of the size of new plants to be added. Having added the manufacturing capacity the actual sale and profit will depend on the future increase in market demand. Depending on the percentage actual increase in market demand, for each of the capacity increase scenario, the company will again have to take decision on actual quantities to be manufactured and prices to be charged. There will be several possible decisions for each of the plant capacity chosen at first level decision. Also for each of this decision the actual sale will depend on demand elasticities, which is uncertain. Thus the company can estimate probabilities of different demand base levels and demand elasticities to assess outcomes of the next level decisions.