Wednesday, April 1, 2009

Decision Tree Analysis: Choosing Between Options By Projecting Likely Outcomes

Decision Trees are useful for helping decision-makers to choose between several courses of action. Their structure allows decision-makers to explore their options and investigate the possible outcomes of those options. Additionally, Decision Trees help decision-makers to form a balanced picture of the risks and rewards associated with each possible course of action. To aid in the decision making process, Decision Trees provide a framework to quantify the values of outcomes with the probabilities of achieving them.

How To Make A Decision Tree:
1.) Draw a small square to represent a decision to be made on the left hand side of a large piece of paper, half way down the page.
2.) From this box, draw lines out towards the right for each possible solution, and write a short description of the solution along the line.
3.) At the end of each line, consider the potential/likely results. If the result taking that particular decision is uncertain, draw a small circle. If this results in another decision needing to be made, draw another square. Squares represent decisions and circles represent uncertain outcomes.
4.) Starting from the new decision square, draw lines out representing the potential options that could be selected. From the circles, draw lines representing possible outcomes.
5.) Repeat steps 2-4 until all possible decisions and outcomes are illustrated.

To begin the decision making process, start by assigning a score to each possible outcome. This score is an estimate of how beneficial the result is. Next, look at each circle and estimate the probability of each outcome.

Then, calculate the value of the uncertain outcomes (multiply the value of the outcomes by their probability). Start on the right hand side of the Decision Tree and work back towards the left. Only record the result to each respective square or circle from each set of calculations.

To evaluate each decision node, write down the cost of each option on each decision line. Then subtract the cost from the outcome value previously calculated. This value represents the benefit of that decision. Once all calculations are complete, choose the option that has the largest benefit (the final decision).
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