Exercise

DecisionTrees
InthisExercise BuildaDecisionTree Decisionnodes Eventnodes Endnodes Calculateexpectedvalues

Duration:60minutes

DecisionScenario
Mr.KeramidastheVicePresidentofNiceCeramicsA.E.callsyouinhisofficetogiveyousomeextra informationaboutthedecisionscenarioyouwereworkingwithinExercise1. HereportsthatNiceCeramicsBusinessAnalysisdepartmenthaslearnedsomemoreinformationthat mayaltertheanalysisreportthatyoumadeinExercise1.Mr.Keramidastellsyouthattheproposed Supertile product must first pass some tests to take some ISO certification for either residential or commercial use, before it can be sold in the market whereas those tests are not necessary for Saviortileproduct.Mr.KeramidasdescribesyouhowISOcertificationprocessworks: The rules for obtaining the commercial usage ISO certification are very strict, so the likelihood of obtaining that certification is only 30%. However if commercial certification is obtained,thiswillresultin900.000asexpectedoriginally. Obtaining an ISO certification for residential usage of the product is less strict, thus is 60% likelytoobtain.Theexpectedsalesareconsiderablylowerastheestimatepredictsnomore than300.000sales. There is alsoa small chance of 10% that the smoke detector will not passany certification test, so the result will be a total failure and NiceCeramics will lose the initial 90.000 investmentcost. The company that will supply the product with the certification charges a 6.000 non refundablefeefortheprocedure. YouhavetomakeanewreporttoMr.Keramidasbearinginmindallthatnewinformation.Todo thatyouneedtoalteryourinitialdecisiontreealittlebitandthentoreevaluateitsoitwillreflect allthisnewinformation.

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DecisionTrees

SolutionusingDETRETUsoftware
Addasequentialdecision
Open the file where you saved the decision tree of Exercise 1. The event node for the successful developmentofSaviortileproductandtheNeithernodewillremainunchanged.Whatwillneedto changeistheeventnodeforthesuccessfuldevelopmentofSupertile,asitcannowleadtoanew decision node followed by some event nodes to depict all the procedure of obtaining the ISO certification. Do the following steps in DETRETU to change the decision tree due to the new information: 1. Clickonthetrianglesymbol attherightsideofthenodeSuccessoftheproductSupertile.This willopenthedialogframeInsertNewBranch. 2. Select the graphic Decision Node and click OK. Two new nodes will be inserted after the end nodeSuccesswhichisnowtransformedintoaDecisionNodeasshowninFigure1.
Figure1

NotethatSuccessnodenowoffersnorevenuetothecompanysothevalue900.000shouldbe replacedby0. 3. ChangethenameofthetopnewnodetoTestsandthebottomnewnodetoNoTests. 4. Typethevalue6000atnodeTestsasthisisthepricethatNiceCeramicshastopaytoproceed withthecertificationtests.YourtreeshouldnowlookliketheoneshowninFigure2. InternationalHellenicUniversity ParaskevopoulosKonstantinos 2

DecisionTrees 5. ClickonthetrianglesymbollocatedattherightsideofnodeTestssotheframedialogInsertNew Branchopens. 6. InInsertNewBranchdialog,selectthegraphicEventNodeandclickOK.Twonewnodeswillbe inserted after the end node Tests which is now transformed into an Event Node as shown in Figure3.
Figure3 Figure2

7. ChangethenameofthetopnewnodetoComISO(CommercialISOcertificate)andthenameof thebottomnewnodetoResISO(ResidentialISOcertificate). 8. Clickonthecirclesymbol attherightofTestsnodetoinsertanewEventnode.Changethe

nameofthisnewnodetoNoISO.ThealteredSuccessbranchafterthecompletionofthisstep shouldlookliketheoneshowninFigure4. InternationalHellenicUniversity ParaskevopoulosKonstantinos 3

DecisionTrees 9. ChangethechancesofeachoneoftheoutcomenodesofnodeTests.InComISO,type30(for 30%chance),inResISOtype60(for60%chance)andfornodeNoISOtype10(for10%chance). TheTestsbranchshouldnowlooklikethefollowingFigure5. 10. Insert the value 900000 in Com ISO node as those will be the sales if Commercial certification succeeds.InnodeResidentialISO,insertthevalue300000asthosewillbethesalesifresidential certificationsucceeds.YourDecisionTreeshouldnowlookliketheoneshowninFigure6. ThistreeasshowninFigure6,offersagoodexampleofsequentialdecision.Therootdecision leadstoatleastotherdecisiononsomebranchpath.Theseconddecisionleadstofurtherevent nodes.Youcanaddmoredecisionnodestorepresenthowtheymustoccurintimeonabranch path.Adecisiontreeiscapabletokeeptrackofmanysequentialdecisions.
Figure5 Figure4

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DecisionTrees

Figure6

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DecisionTrees

Solvethetree
After completing all the above steps your decision tree now depicts the new information Mr. Keramidasgaveyouaboutthetwoprojects.Nowitstimetosolvethetreeandmakethefinalreport thatyouwillgivetohim.Dothefollowingsteps. InDETETRUClickmenuTree>Solve.ThesolvedtreeasresultsinDETRETUisshowninFigure7.

Figure7

ThetreeissolvedusingallthestepsdescribedinExercise1.TheSaviortilehasbecomenowthebest choiceforNiceCeramics.Thenewinformationenteredinthetree,dramaticallyreducestheEMVfor Supertile.ThemainreasonforthelowerEMVisdescribedbelow. Obtainingarevenueofabout900.000isstillpossiblewithacommercialISOcertification,butthis outcome has a low chance to come true (only 30%). A smaller revenue of 300.000 with a 60% chanceisstillpossiblewitharesidentialISOcertification,butthisisnotgoodenoughtooffsetthe resulting lower EMV at this node. Since you must use this EMV as the input for the development outcomechancenodetheoverallEMVofSupertilefallsbelowthatofSaviortile.

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DecisionTrees ThemainreasonforthereducedEMVofSupertileistherelativelymodestprobabilityofobtaining the optimal commercial ISO certification. This lowered probability multiplied by the anticipated revenue significantly lowers the overall EMV for that branch. Even if the probability of obtaining a commercial ISO certification is increased to 50% the resulting EMV is still less than that for the Saviortile. YoucansummarizeyoureporttoMr.Keramidasasfollows. TheSupertileproductisnowsignificantlymoreriskyasgreateruncertaintyexists. TheSupertileproductprofitsareless,especiallyinthecaseofnotobtainingacommercialISO certification. This combination of greater risk potentially fewer profits, significantly reduces the attractivenessoftheSupertileproduct.

InternationalHellenicUniversity ParaskevopoulosKonstantinos