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Decision Tree: - Square Nodes: Denote Decision Points - Circular Nodes: Denote Chance Events

- A decision tree is a schematic representation of alternatives and their consequences in a tree-like diagram. It contains decision and chance nodes. - The expected value of perfect information is the difference between the expected payoff with complete information and the expected payoff with risk. It can be calculated in two ways. - Sensitivity analysis determines the range of probabilities over which the best alternative remains the same. It involves constructing a graph and using algebraic equations of slopes and alternatives.

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80 views7 pages

Decision Tree: - Square Nodes: Denote Decision Points - Circular Nodes: Denote Chance Events

- A decision tree is a schematic representation of alternatives and their consequences in a tree-like diagram. It contains decision and chance nodes. - The expected value of perfect information is the difference between the expected payoff with complete information and the expected payoff with risk. It can be calculated in two ways. - Sensitivity analysis determines the range of probabilities over which the best alternative remains the same. It involves constructing a graph and using algebraic equations of slopes and alternatives.

Uploaded by

AMT
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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DECISION TREE

• a schematic representation of the alternatives available and their possible consequences.


• a treelike appearance of the diagram
• useful for analyzing situations that involve sequential decisions
A decision tree is composed of a number of nodes that have branches emanating from
them.
• Square Nodes : denote decision points
• Circular Nodes : denote chance events
• Read the tree from left to right.
• Analyzed the tree from right to left. - starting from the last decision that might be made.
EXPECTED VALUE OF PERFECT INFORMATION (EVPI)

• The difference between the expected payoff with perfect information and the expected payoff under
risk.

• 2 ways to determine the EVPI.


• Compute the expected payoff under certainty and subtract the expected payoff under risk.
EVPI = expected payoff - expected payoff
under certainty under risk

• Use the regret table to compute the EVPI. Find the expected regret for each alternative. The
minimum the expected regret is equal to the EVPI.
EXAMPLE:
Low Moderate High
.30 .50 .20

• Best payoff under low demand is P10, moderate demand P12 and high demand P16.
• The expected payoff under certainty:
.30(P10) + .50(P12) + .20(P16) = P 12.2
• The expected payoff under risk:
.30(P7) + .50(P12) + .20(P12) = P 10.5
• Expected value of perfect information:
EVPI = P 12.2 – P10.5
EVPI = P 1.7
EXAMPLE
Alternatives Low Moderate High Low Moderate High
A P0 P2 P6 .30 .50 .20
B 3 0 4
C 14 10 0

A = .30(0) + .50(2) + .20(6)


= 2.2

B = .30(3) + .50(0) + .20(4)


= 1.7 (MINIMUM)

C = .30(14) + .50(10) + .20(0)


= 9.2
SENSITIVITY ANALYSIS

• Determining the range of probability over which the choice of


alternatives would remain the same.

• It involves constructing a graph and using algebra.


#1 #2

EXAMPLE
Alternative A 4 12
B 16 2
C 12 8

A
C

B Best C Best A Best


#1 #2 Slope Equation
A 4 12 12 – 4 = +8 4 + 8P(2)
B 6 2 2 – 16 = -14 16 – 14P(2)
C 12 8 8 – 12 = -4 12 – 4P(2)

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