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Decision Tree, EMV, Decision Making Under Risk, Multistage Decision Making

Decision tree is a graphical representation of decision making that uses nodes and branches to layout the alternatives, potential outcomes, associated probabilities, and expected monetary values. It is useful for depicting multi-stage decision processes where one decision leads to subsequent decisions. The document provides several examples of using decision trees to model decision making problems, identify the optimal decisions, and calculate expected monetary values at each decision node.

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Gaurav Sonkar
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6K views13 pages

Decision Tree, EMV, Decision Making Under Risk, Multistage Decision Making

Decision tree is a graphical representation of decision making that uses nodes and branches to layout the alternatives, potential outcomes, associated probabilities, and expected monetary values. It is useful for depicting multi-stage decision processes where one decision leads to subsequent decisions. The document provides several examples of using decision trees to model decision making problems, identify the optimal decisions, and calculate expected monetary values at each decision node.

Uploaded by

Gaurav Sonkar
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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DECISION TREE

Decision tree is a graphical representation of the decision process indicating decision alternatives, states of nature, probabilities attached to the states of nature and profits and losses associated with it. It consists of nodes & branches. The following symbols are used:

Decision node State of nature Branches


A decision tree is generally useful for multistage situation which involves a series of decisions each depends on the preceding one.

A decision tree look like

ILLUSTRATION 1
Suppose we have the decision making problem represented by the following table:

Course of Action
Demand Prob
0.10 0.50 0.40
S1 (Subcontracting) S2 (Begin Overtime) S3 (Construct facilities)

Low Medium High

10 50 50

-20 60 100

-150 20 200

Show this decision situation in the form of a decision tree & indicate the most preferred decision & corresponding expected value.

SOLUTION
A decision tree which represents possible course of action & state of nature are shown as: 0.1 X 10 = 1
p = 0.5

0.5 X 50 = 25

EMV = 46

EMV = 75

EMV = 68

0.4 X 50 = 20 0.1 X -20 = -2 0.5 X 60 = 30 0.4 X 100 = 40


0.1 X -150 = -15

EMV = 75

0.5 X 20 = 10 0.4 X 200= 80

SINCE NODE 3 HAS THE HIGHEST EMV, THEREFORE THE DECESION AT NODE D WILL BE CHOOSEN THE COURSE OF ACTION S3 I.E. CONSTRUCT NEW FACILITY.

ILLUSTRATION 2
A businessman has two independent investment portfolios A & B available to him but he lacks the capital to undertake both of them simultaneously. He can choose A first and then stop, If A is successful then take B or of vice-versa The probability success of A is 0.6 while that for B it is 0.4. Both investment schemes requires an initial capital outlays of Rs 10,000 and both return nothing if the venture is unsuccessful. Successful completion of A will return Rs.20000 and successful completion of B returns Rs. 24000. Draw a decision tree & determine best strategy.

SOLUTION
Rs 9600

- Rs 10000

Rs 12000

f = 0.4 - Rs 10000

ILLUSTRATION 3
A large steel manufacturing company has three option with regards to production: (i) produce commercially (ii) build pilot plant (iii) stop producing steel. The management has estimated that their pilot plant if built has 0.8 chances of high yield & 0.2 chances of low yield. If the pilot plant does show a high yield, management assigns a probability of 0.75 that the commercial plant will also have a high yield. If the pilot plant shows a low yield there is only a 0.1 chance that the commercial plant will show a high yield. Finally managements best assessment of the yield on a commercial size plant without building a pilot plant first has a 0.6 chance of high yield. A pilot plant will cost Rs. 3,00,000. The profits earned under high & low yield conditions are Rs. 1,20,00,000 and Rs. 12,00,000 respectively. Find the optimum decision for the company.

SOLUTION

Rs 0

Rs 0

ILLUSTRATION 4
Mr. X of ABC Ltd. Wants to introduce a new product in the market. He has a choice of two different research and development plans A & B. A costs Rs. 10 lakhs and has a 40 percent chance of success where as B costs Rs. 5 lakhs with a 30 percent chance of success. In the event of success, Mr. X has to decide whether or not to advertise the product heavily or lightly. Heavy advertising will cost Rs. 4 lakhs but gives 0.7 probability of full acceptance and 0.3 probability of partial acceptance by the market. Light advertising will cost Rs. 1 lakh with the probability 0.5 of full acceptance and 0.5 probability of partial acceptance. Full market acceptance of the product develop as per plan A would be worth Rs. 40 lakhs and as per plan B would be worth Rs. 30 lakhs. Partial acceptance in both cases will be worth Rs 20 lakhs. Which plan Should Mr. X adopt and what sort of advertising will be done for marketing the product? Solve the problem with the help of decision tree.

SOLUTION A decision tree which represents the possible courses of action &
state of nature is shown in following figure.
Rs. 30 L Rs. 12 L Rs. 34 L Rs. 40 L

C2
Rs. 20 L Rs. 40 L

C1
Rs. 2 L Rs. 0

C3
Rs. 30 L Rs. 27 L Rs. 20 L Rs. 30 L

C4
Rs. 7.2 L

C5
Rs. 24 L
Rs. 20 L Rs. 30 L

Rs. 0

C6
Rs. 25 L Rs. 20 L

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