INSTITUTE –University School of

Business
DEPARTMENT -Management
MBA
Project Finance and Financial Modelling
: 22BAT-736
MSC: Dr. Rakhi Arora
Assistant Professor
Chandigarh University

DISCOVER . LEARN . EMPOWER

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 Decision Tree
Analysis

Course Outcome
Course Description Blooms
Outco Taxonomy
me Level
1 To understand the basic project financing framework, Understand/ Will be covered in this
concepts and process of project finance, Remember lecture
2 To apply the necessary qualitative and quantitative Apply
tools and techniques for mitigation of the project risk
3 To evaluate different project financing analysis Analyze
techniques to compare the outcomes of different
projects
4 To structure and appraise financing for large & Evaluate
medium projects
5 To utilise the understanding of financial modelling to Design/Create
develop financial models for projects
https://www.expertmile.com/
 What is a Decision Tree?
• A Visual Representation of Choices, Consequences,
Probabilities, and Opportunities.
• A Way of Breaking Down Complicated Situations Down
to Easier-to-Understand Scenarios.
• Decision tree analysis is a powerful decision-making
tool which initiates a structured nonparametric
approach for problem-solving.
• It facilitates the evaluation and comparison of the
various options and their results, as shown in a
decision tree.
• It helps to choose the most competitive alternative. Decision Tree
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 Decision Tree Example

40 % Chance of a Good Economy

.4 Profit = $6M
Expand Factory
Cost = $1.5 M
.6 60% Chance Bad Economy
Profit = $2M

Good Economy (40%)

.4 Profit = $3M
Don’t Expand Factory
Cost = $0 .6 Bad Economy (60%)
Profit = $1M

NPVExpand = (.4(6) + .6(2)) – 1.5 = $2.1M

NPVNo Expand = .4(3) + .6(1) = $1.8M

$2.1 > 1.8, therefore you should expand the factory

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What is a Decision Tree?
A decision tree is the graphical depiction of all the possibilities or outcomes to solve a
specific issue or avail a potential opportunity.
It is a useful financial tool which visually facilitates the classification of all the probable
results in a given situation.

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What is a Decision Tree?

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Steps in Decision Tree Analysis

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Process…
• The first step is understanding and specifying the problem area for which
decision making is required.
• The second step is interpreting and chalking out all possible solutions to the
particular issue as well as their consequences.
• The third step is presenting the variables on a decision tree along with its
respective probability values.
• The fourth step is finding out the outcomes of all the variables and specifying it in
the decision tree.
• The last step is highly crucial and backs the overall analysis of this process. It
involves calculating the EMV values for all the chance nodes or options, to figure
out the solution which provides the highest expected value.

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Example
• ABC Ltd. is a company manufacturing skincare products. It was found that the business is at
the maturity stage, demanding some change. After rigorous research, management came up
with the following decision tree:

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Example
• In the above decision tree, we can easily make out that the company can expand its existing
unit or innovate a new product, i.e., shower gel or make no changes. Given below is the
evaluation of each of these alternatives:
Expansion of Business Unit:
• If the company invests in the development of its business unit, there can be two possibilities,
i.e.:
• 40% possibility that the market share will hike, increasing the overall profitability of the
company by ₹2500000;
• 60% possibility that the competitors would take over the market share and the company may
incur a loss of ₹800000.
• To find out the viability of this option, let us compute its EMV (Expected Monetary Value):

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Example
New Product Line of Shower Gel:
•If the organization go for new product development, there can be
following two possibilities:
•50% chances are that the project would be successful and yield
₹1800000 as profit;
•50% possibility of failure persists, leading to a loss of ₹800000.
•To determine the profitability of this idea, let us evaluate its EMV:

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Example
Do Nothing:
If the company does not take any step, still there can be two outcomes,
discussed below:
40% chances are there that yet, the organization can attract new
customers, generating a profit of ₹1000000;
60% chances of failure are there due to the new competitors, incurring a
loss of ₹400000.
Given below is the EMV in such circumstances:

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Advantages of Decision Tree Analysis

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video
• https://www.youtube.com/watch?v=a5yWr1hr6QY

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Assessment Pattern

Components HT-1 HT-2 Assignment Surprise Business Quiz GD Forum Attendance Scaled
Test Marks
Max. Marks 10 10 6 4 4 4 2 40

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References
•Text Books:
•1. Edward Yescombe, Principles of Project Finance, Yecombe Consulting Ltd.,
Academic Press
•2. Michael Rees, Principles of Financial Modelling: Model Design and Best
Practices Using Excel and VBA , The Wiley Finance Series)

•Reference Book:-
•1. Edward Bodmer, Corporate and project finance modeling, Wiley Finance Series

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THANK YOU

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