KT 10: 3.3.3 Decision Trees

Question 1

Decision trees

Answer 1

diagrams that set out all the options available when making a decision, plus an estimate of their likelihood of occurring.

Question 2

Actual value

Answer 2

although known as “actual values” or “payoffs”, these are the forecasts of the net cash flow which result from following a sequence of decisions and chance events through a decision tree. They should always be shown at the ends of the branches of the tree.

Question 3

Expected values

Answer 3

these are the forecast actual values adjusted by probability of their occurrence. Although called “expected”, they are not the actual cash flows which result. Expected equals actual times probability.

Question 4

Net gains (or losses)

Answer 4

subtracting the initial outlay from the expected value to find out whether or not a decision is likely to produce a surplus.

Question 5

Node

Answer 5

a point in a decision tree where chance takes over. It is denoted by a circle, and at that point it should be possible to calculate the expected value of this pathway.

Question 6

Probability

Answer 6

the likelihood of something occurring. This can be expressed as numerical value, which can be a percentage. The probability of something certain is 100% or 1. The probability of impossible is zero. So probabilities from from 1 to zero.