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Decision Tree

is a graphical representation of variousdecision alternatives and the sequence

of events as if they were branches of

tree.

What is Decision Tree?

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A

Advantages

Simple to understand and interpret

Enables a business to quantify decision makin

Useful when the outcomes are uncertain

Allows comparison of different possibledecisions to be made

Performs well with large data in a short time

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A

Disadvantages

Diagrams may become more complicated

Accuracy of the data

Reliability of probabilities

Data may be historical

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COMPONENTS

1. DECISION NODE

2. CHANCE NODE

3. T

ERMINAL NOD

E

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Decision

Node

Referred to as the root of the tree

which is placed to the left and is

represented by a small square.

Decision nodes represent points at

which the decision maker has to make

a choice of one alternative from a

number of possible alternatives

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Chance

Node

Shows occurrence of events over which the decision maker has nocontrol.

From a chance node, several lines are drawn showing different

possible event.

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Terminal Node

Right Side of the tree at the end of the branches.

Also referred to as a leaf as it is the final destinationwhich has no other paths leading awayfrom it.

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How to Use the Tool

DECISION

NODE

CHANCE

NODE

BRANCH

BRANCH

CHANCENODE

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DECISION TREE PROBLEM

Gabbar company is currently working with a process which after paying for materials,

labour etc., brings a profit ofRs.12000. The following alternatives are made available to

the company.

(i) The company can conduct research (R1) which is expected to cost Rs. 10,000 having 90%

chances of success. If it proves a success, the company will get a gross income of Rs. 25000

(ii) The company can conduct research (R2) which is expected to cost Rs. 8000 having a

probability of60% success, the gross income will be Rs. 25000.

(iii) The company can pay Rs.6,000 as royalty for the new process which will bring a gross

income of Rs. 20,000.

(iv) The company continues the current process.

Because of limited resources, it is assumed that only one of the two types of research can becarried out at a time .

Use decision tree analysis to locate the optimal strategy for the company

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Continue Current

Process

New Process

R1

R2

Success

Success

Failure

Failure

25,000

0-10,000

-6,000

-8,000

(0.10)

(0.90)

(0.60) 25,000

0

20,000

12,000

(0.40)

22,500

15,000

14,000

SOLUTION

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Recommendeddecision to the

company is to go forthe new process at acost of Rs.6,000.The correspondingexpected payoff isRs.14,000.

Conclusion

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