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Decision-Making Techniques

Decision trees

  • 7 things to know
  • Paper 2 and Paper 3

Overview

Nodes and branches, expected monetary value and net gain, and the strengths and limitations of putting probabilities on business outcomes.

What you need to know

Answer each one before you reveal it.

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Key term

What is a decision tree, and what do its nodes represent?

Numbers

How are expected monetary value and net gain calculated?

Numbers

How is a decision tree solved?

Key term

How are inferior options shown on a decision tree after backward induction?

Key term

Under what circumstances can decision trees become overly complex?

Numbers

State the expected-monetary-value formula.

Numbers

State the decision-tree net-gain formula.

Questions from this subtopic

Each one with the model answer underneath.

  1. 1

    What is a decision tree?

    Model answer

    A mathematical model that represents the likely outcomes of different decisions, showing decision points, chance nodes, probabilities, and expected monetary values.

  2. 2

    What does a square node represent on a decision tree?

    Model answer

    A decision point where the business chooses between alternative courses of action.

  3. 3

    What does a circle node represent on a decision tree?

    Model answer

    A chance node where different outcomes may occur with associated probabilities.

  4. 4

    What do branches extending from a decision node represent?

    Model answer

    The different options available to the decision maker.

  5. 5

    What information is shown on branches extending from a chance node?

    Model answer

    Possible outcomes, each labelled with a probability and financial value.

  6. 6

    What must the probabilities at each chance node sum to?

    Model answer

    1.0 (or 100%).

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Net gain = − initial cost.
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