Expected Value Decision Analysis, Essay Example

Decision Tree Charts

Part A

To determine the expected values of the four nodules, you should multiply the probability and the expected gain.

Let us number the probability nodes as A B C D from the top to the bottom.

Node A (0.4 * $500000) + (0.4 * $25000) + (0.2* $1000) = $210,200

Node B (0.1* $500000) + (0.2 * $25000) + (0.7* $1000) = $55,700

Node C (0.3 * $200000) + (0.4 * $10000) + (0.3 * $3000) = $64900

Node D (0.6 * $ 10000) + (0.4 * $1000) = $6400

To determine the expected value of the decision nodes you compare the probability nodes in each decision node and get the node with the highest expected value.

Let us name the decision nodes K and L from the top to bottom, if we compare the probability nodes of the first decision node i.e. K it will be noted the highest expected value is $210000 hence this is the expected value of the node K.

Comparing the probability nodes of L we notice that the highest expected value is $64900 and it is thus the expected value of the decision node L.

Part B

To determine which decision to take we compare the two nodes and get the node with the highest expected value. In this case node K has the highest expected value of $210000 and thus decision node K is the most favourable. The company should develop a new product and it should also develop thoroughly because this option gives the highest expected value.