Sunday, August 29, 2010


Usefulness of Decision Tree Approach

The decision tree approach is extremely useful in handling the sequential investments. Working backwards from future to presents we are able to eliminate unprofitable branches and determine optimum decision at various decision points. The merits of the decision tree approach are:
  • Clarity. It clearly brings out the implicit assumptions and calculations
  • Graphic visualisation. It allows a decision maker to visualise assumptions and alternatives in graphic form, which is usually much easier to understand than the more abstract, analytical form.

However, the decision tree diagrams can become more and more complicated as the decision maker decides to include more alternatives and more variables and to look farther and farther in time. It is complicated even further if the analysis is extended to include interdependent alternatives and variables that are dependent upon one another; for example, sales volume depends on market share which depends on promotion expenses. The diagram itself quickly becomes cumbersome and calculations become very time consuming or almost impossible.

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