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http://www.bized.co.uk

Copyright 2006 Biz/ed

Decision tree

A decision tree is a decision support tool that

uses a tree like graph or model of decisionsand their possible consequences,including chance event outcomes, resourcecosts, and utility. It is one way to displayan algorithm.


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Decision trees are commonly usedin operations research, specifically in decisionanalysis, to help identify a strategy most likelyto reach a goal.

A decision tree is a flowchart-like structure inwhich internal node represents test on anattribute, each branch represents outcome oftest and each leaf node represents class label(decision taken after computing all attributes).

A path from root to leaf representsclassification rules.


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A decision tree consists of 3 types of nodes:

Decision nodes - commonly represented bysquares

Chance nodes - represented by circles

End nodes - represented by triangles


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Decision Trees


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Planning Tool


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Decision Trees

Enable a business to quantifydecision making

Useful when the outcomes areuncertain

Places a numerical value on likely

or potential outcomes Allows comparison of different

possible decisions to be made


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Decision Trees

Limitations: How accurate is the data used

in the construction of the tree?

How reliable are the estimatesof the probabilities?

Data may be historical does this datarelate to real time?

Necessity of factoring in the qualitativefactors human resources, motivation,reaction, relations with suppliers and otherstakeholders


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Process


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The Process

Expand by opening new outlet

Maintain current status

Economic growth rises

Economic growth declines

0.7

0.3

Expected outcome300,000

Expected outcome-500,000

0

A square denotes the point where a decision is made, In this example, a business is contemplating

opening a new outlet. The uncertainty is the state of the economyif the economy continues to grow

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.

There is also the option to do nothing and maintain the current status quo! This would have an outcome of

0.

The circle denotes the point where different outcomes could occur. The estimates of the probability and theknowledge of the expected outcome allow the firm to make a calculation of the likely return. In this example

it is:

Economic growth rises: 0.7 x 300,000 = 210,000

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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Advantages


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Disadvantages


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Thank you

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