DECISION TREE ANALYSIS OF RISK TECHNIQUE

SUBMITTED BY:

APURBO PAUL

TWINKLE VERMA
A decision tree analysis is a specific technique in which a diagram (in this case referred to as
a decision tree) is used for the purposes of assisting the project leader and the project team
in making a difficult decision.
Business or project decisions vary with situations, which in-turn are fraught with threats and
opportunities. Calculating the Expected Monetary Value of each possible decision path is a
way to quantify each decision in monetary terms. Calculating Expected Monetary Value by
using Decision Trees is a recommended Tool and Technique for Quantitative Risk Analysis.
STEPS FOR DECISION TREE ANALYSIS

• Document a decision in a decision tree.

• Assign a probability of occurrence for the risk pertaining to that decision.
• Assign monetary value of the impact of the risk when it occurs.
• Compute the Expected Monetary Value for each decision path.
DECISION TREES EXAMPLE – SCENARIO

• Suppose your organization is using a legacy software. Some influential stakeholders

believe that by upgrading this software your organization can save millions, while others
feel that staying with the legacy software is the safest option, even though it is not
meeting the current company needs. The stakeholders supporting the upgrade of the
software are further split into two factions: those that support buying the new software
and those that support building the new software in-house. Confusion reigns in the
meeting room with stakeholders pointing out negative risks for each option!!!
In this scenario, you can either:
• Build the new software: To build the new
software, the associated cost is $500,000.
• Buy the new software: To buy the new software,
the associated cost is $750,000.
• Stay with the legacy software: If the company
decides to stay with the legacy software, the
associated cost is mainly maintenance and will
amount to $100,000.
The diagram depicts the decision tree. Now, you can calculate the Expected
Monetary Value for each decision. The Expected Monetary Value associated with
each risk is calculated by multiplying the probability of the risk with the impact.
By doing this, we get the following:
• Build the new software: $ 2,000,000 * 0.4 = $ 800,000
• Buy the new software: $ 2,000,000 * 0.05 = $ 100,000
• Staying with the legacy software: $ 2,000,000 * 1 = $ 2,000,000
• Now, add the setup costs to each Expected Monetary Value:
• Build the new software: $ 500,000 + $ 800,000 = $ 1,300,000
• Buy the new software: $ 750,000 + $ 100,000 = $ 850,000
• Staying with the legacy software: $ 100,000 + $ 2,000,000 = $ 2,100,000
DECISION TREES EXAMPLE – MAKING THE
DECISION
• Looking at the Expected Monetary Values computed in this Decision Trees example, you
can see that buying the new software is actually the most cost efficient option, even
though its initial setup cost is the highest. Staying with the legacy software is by far the
most expensive option.
Thank You