ACCA SBL Syllabus G. Finance In Planning And Decision-Making - Decision trees - Notes ^{7 / 11}

Decision trees and multi-stage decision problems

A decision tree is a diagram showing several possible courses of action and possible events and the potential outcomes for each course of action.  

Each alternative course of action or event is represented by a branch, which leads to subsidiary branches for further courses of action or possible events.

In the exam, you will not have to draw decision trees but it will be important that you can understand and interpret them.

 Look at this example - you start from the right and work to the left

So, Look at F
F = (1,500,000 x 0.95  + 600,000 x 0.05) = 1,455,000
E = 1,455,000 - 550,000 = 905,000
B = 905,000 x .8 = 724,000
A = 724,000 - 50,000 survey = 674,000

Now lets go again from the right

1,500,000 x 0.75 + 600,000 x 0.25 = 1,275,000 - 550,000 (large premises) = 725,000

Now again from the right

1,500,000 x 0.6 + 600,000 x 0.4 = 1,140,000 - 300,000 (small premises) = 840,000

From the above - compare the final figures and you can see the small premises is probably the best option

Note:

A square is used to represent a decision point.  At a decision point, the decision maker has a choice of which course of action he wishes to undertake.

A circle is used as an outcome point.  The branches from the circle are always subject to probabilities.