• Decision tree analysis is a tool used in decision-making to evaluate different options and potential outcomes.
• It involves creating a diagram that shows the options connected with a decision and the possible outcomes and economic returns that may result.
• Decision Trees are graphical in nature i.e. they are mainly diagrams.

#### Main features of a decision tree

• As already said a decision tree is a graphical representation of a decision problem that shows the different options available, the possible outcomes that could result from each option, and the probability of each outcome occurring.
• The tree is constructed from left to right, with the options represented as branches that emanate from a decision node on the left-hand side of the tree.
• Each option branch is then subdivided into further branches, which represent the different possible outcomes that could result from that option.
• At the end of each outcome branch, shown as a circle (or another shape) is used to represent the potential outcome.
• Alongside each potential outcome, the probability of that outcome occurring is shown, often as a percentage.
• The economic returns associated with each outcome are also typically shown alongside the outcome and probability, such as in terms of revenue or profit.
• Decision-making trees can be helpful for breaking down complex decision problems into manageable parts and for making explicit the underlying assumptions and probabilities associated with different options and outcomes.
• The accuracy of data used in decision tree analysis is crucial, as probabilities may not always be true for the future.
• Decision trees aid the decision-making process, but they cannot replace the consideration of non-numerical and qualitative factors.

#### A fictitious example

Below are some steps an example of a company considering opening a branch in rural Zimbabwe can use to carry out decision tree analysis:

1. Identify the decision to be made:
• Whether or not to open a new branch in rural Zimbabwe.
1. Identify the options available:
• Option 1: Open the new branch in rural Zimbabwe.
• Option 2: Do not open the new branch in rural Zimbabwe.
1. Identify the possible outcomes of each option:
• Option 1 outcomes:
• Outcome 1: The new branch is successful and generates a profit of \$100,000 per year.
• Outcome 2: The new branch is moderately successful and generates a profit of \$50,000 per year.
• Outcome 3: The new branch is not successful and generates a loss of \$50,000 per year.
• Option 2 outcomes:
• Outcome 4: The company does not expand and maintains its current profit of \$500,000 per year.
1. Determine the probabilities of each outcome:
• Outcome 1: 30% chance of occurring.
• Outcome 2: 50% chance of occurring.
• Outcome 3: 20% chance of occurring.
• Outcome 4: 100% chance of occurring.
1. Calculate the expected values for each option:
• Option 1 expected value: (0.3 x \$100,000) + (0.5 x \$50,000) + (0.2 x -\$50,000) = \$35,000
• Option 2 expected value: (1 x \$500,000) = \$500,000
1. Determine the best decision based on the expected values:
• Option 1 has an expected value of \$35,000.
• Option 2 has an expected value of \$500,000.
• Therefore, the best decision would be to not open the new branch in rural Zimbabwe, as it has a higher expected value.

Note: These figures are purely hypothetical and do not reflect the actual market conditions or financial situation of any specific company. 