Decision Tree Analysis:

You use decision tree analysis when you have multiple choices and you want to select the best option.

In this technique no special formula is required. You draw the diagram, one branch for each option, and using the expected monetary value formula you calculate the EMV of each choice and make the decision based on this calculation.

Example:

Based on the below decision tree, find the EMV of choice A, and determine that which choice is better than the rest.

Solution:

For Choice A, there is a 20% chance of spending 100, and 80% (100 20) chance of spending 200.

Hence, the EMV of Choice A = 20% of 100 + 80% of 200.

= 0.2*100 +0.8*200

= 20 + 160

= 180

Hence, the EMV of Choice A is 180 USD.

Now to decide on the best option, we will calculate the EMV of other choices and select the option with the highest EMV because all risks are opportunities.

Since we have calculated the EMV of A, we will go for

B, and C. EMV of Choice B = 40% of 50 + 60% of 150

= 0.4*50 + 0.6*150

= 20 + 90

= 110

Hence, the EMV of Choice B is 110.

EMV of Choice C = 50% of 150 + 50% of 350

= 0.5*150 +0.5*350

= 75 + 175

= 250

Since the EMV of Choice C is the highest in all choices, Choice C will be the best option to go with.

Practice Question:

Based on the below decision tree, find the EMV of choice A, B, C, and determine which choice is better than the rest.

2015100 $ 200 40950 Chake Decision 150 509 150 $350 $ 120 35% $ 200 Choice 70% $180 Choice B Decision Choice C $ 150 40% $120 $ 140