Thursday, 23 February 2017

Decision Tree

Why make a decision tree?

Decisions, decisions—we all have to make them. When a business makes the wrong decision it can be a costly mistake resulting in financial loss, poor use of resources, and negative impact on a company’s image. Thankfully, a decision tree diagram can help. While it’s not a crystal ball, it can provide some valuable insight that can steer you in the right direction. One of the biggest benefits of a decision tree is that it can take emotions out of the equation.

Decision tree diagrams are often used by businesses to plan a strategy, analyze research, and come to conclusions. Lenders and banks use decision trees to calculate the riskiness of loans and investment opportunities. They are also a popular choice for infographics, often appearing in magazines or shared on social media. The point is that decision trees can be used to evaluate just about any question or concern and visualize possible outcomes.

Anatomy of a decision tree

One of the nice things about a Decision Tree Diagram is that there aren’t a lot of elements. The key elements are called nodes, and appear as a square or circle with branches (lines) connecting them until a result is reached. Squares represent decisions, while circles are for uncertain outcomes.

Nodes have a minimum of two branches extending from them. On each line write a possible solution and connect it to the next node. Continue to do this until you reach the end of possibilities and then draw a triangle, signifying the outcome.

Once you’ve got the basic layout of a decision tree complete, you can add values to each line to garner more intelligence. Here’s how to do it:

1. Look at each line and add an amount to each.

2. To analyze your options numerically, add an estimate for the probability of each outcome. Note: When adding percentages all the lines from a single node need to equal 100, if you’re using fractions they need to add up to 1.

3. Assign a possible amount to each triangle at the end of the branches.

4. Calculate the results by multiplying the result by the percentage probability for each end branch in that outcome and subtract the cost of that course of action. You’ll end up with an estimate of what that particular outcome could yield.

Here’s an example:

decision tree example

Note: If you have a large tree with many branches, calculate the numbers for each square or circle and record the results to get the value of that decision. Start on the right side of the tree and work towards the left

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