OM - Session 10 - Decision Trees PDF
OM - Session 10 - Decision Trees PDF
OM - Session 10 - Decision Trees PDF
Choices, Consequences,
Probabilities, and
Opportunities.
A way of breaking down
complicated situations down
to easier-to-understand
scenarios.
Decision Tree
Decision nodes: represented as boxes.
Lines coming from these nodes represent
different choices
Don’t 2
Expand
0.6 5
Bad economy
1 Good economy
6
0.4
Expand
3
0.6
7
Bad economy
Terminal Cost Revenue Profit
node
4 0 300,000 300,000
5 0 100,000 100,000
Don’t 2
Expand
0.6 5
Bad economy
1 Good economy
6
0.4
Expand
EMV: 210,000
3
0.6
7
Bad economy
Your company is considering whether it should tender for
two contracts (MS1 and MS2) on offer from a government
department for the supply of certain components. The
company has three options:
Tender for MS1 only; or
Tender for MS2 only; or
Tender for both MS1 and MS2
If tenders are to be submitted, the company will incur
additional costs. These costs will have to be entirely
recouped from the bid price. The risk, of course, is that if a
tender is unsuccessful the company will have made a loss.
The cost of tendering for contract MS1 only is INR
50000. The component supply cost if the tender is
successful would be INR 18000.
The cost of tendering for contract MS2 only is INR
14000. The component supply cost if the tender is
successful would be INR 12000.
The cost of tendering for both contracts MS1 and MS2 is
INR 55000. The component supply cost if the tender is
successful would be INR 24000.
For each contract, possible tender prices have been
determined. In addition, subjective assessments have
been made of the probability of getting the contract with
a particular tender price as shown below.
Note here that the company can only submit one tender
and cannot, for example, submit two tenders (at
different prices) for the same contract.
What do you suggest the company should do and why?
Possible Probability of
Option tender prices getting
(INR) contract
130,000 0.20
MS 1 only
115,000 0.85
70,000 0.15
MS 2 only 65,000 0.80
60,000 0.90
190,000 0.05
MS1 and MS2
140,000 0.65
A company faces a decision with respect to a product
(codenamed M997) developed by one of its research
laboratories.
It has to decide whether to proceed to test market M997 or
whether to drop it completely.
It is estimated that test marketing will cost £100K. Past
experience indicates that only 30% of products are successful
in test market.
If M997 is successful at the test market stage then the
company faces a further decision relating to the size of plant
to set up to produce M997.
A small plant will cost £150K to build and produce 2000 units
a year whilst a large plant will cost £250K to build but produce
4000 units a year.
The marketing department has estimated that there is a 40%
chance that the competition will respond with a similar
product and that the price per unit sold (in £) will be as
follows (assuming all production sold):
Competition respond 20 35