Decision Trees

• Decision trees are graphs that branch out with each branch offering different outcomes and their possible consequences. The tree is the most important tool used to read probabilities of financial results and resource costs. It also evaluates the risks involved with decisions having to do with quantitative amounts of funds.
  
  The goal of this exercise is to compare the outcomes from having taken two different routes when a financial decision is made.
  
  Develop a decision tree based on a fictitious investment firm. Construct the tree so that is has two different computational values. The first should give you a positive outcome dependent on the expected amount of calculated funding distributed to the firm. The second computational value should compute to a negative result. Each value should give you better knowledge in determining the most cost-effective solution to generate the most income for the firm.
  
  Note that your decision tree must include tree nodes. A node is the predecessor to a new branch that determines what result will happen if that route is taken. The three tree nodes include decision nodes (represented by squares) chance nodes (represented by circles) and end nodes (represented by triangles).
  
  After you have completed a decision tree, you should then be able to translate the tree into a line graph with the applicable values.
  
  

Problem Solving

• Create a plausible situation with a fictitious company using decision trees and the annual returns on investment they idicate. Analyze possible outcomes based on your results. Here is one to get you started.
  
  Buff Bodies Gyms divides their annual return on investment into two phases. You may invest in one phase or both, but if you invest in the first phase, you must also do so in the second. Invest $1,000 on the phase(s) you choose and calculate an 8 percent per year discount rate. Diagram a decision tree to evaluate how much you will profit for each circumstance if the company delivers a 60 percent return on investment increase from its revenue. Do the same for a 40 percent return on investment decrease.
  
  By practicing this exercise, you can build your ability to read and understand the plethora of conditions that can arise when you decide to invest in business and indulge in financial corporate management.