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