What is decision tree. Explain with the help of an example.

2. What’s a Decision Tree?
 A decision tree is a type of diagram that clearly
defines potential outcomes for a collection of
related choices. In project management, a
decision tree analysis exercise will allow project
leaders to easily compare different courses of
action against each other and evaluate the risks,
probabilities of success, and potential benefits
associated with each.

3. It’s important to note that a proper
decision tree has four main elements:
 Decision Nodes: A decision node, represented on our decision
tree diagram as a square, indicates a choice that needs to be
made.
 Chance Nodes: A circle represents a chance node and is used
to signify uncertain outcomes. These nodes are used when
future results are not guaranteed.
 End Nodes: End nodes, like the name suggests, represent the
end of a diagram and illustrates a final outcome.
 Branches: Lastly, we have branches. Branches are what
connect the nodes together. Each branch represents a
potential choice and should be clearly labeled.

4. Example:
 Suppose a organization is using a legacy software.
Some influential stakeholders believe that by
upgrading this software the 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.

5. Building the Decision Tree:
 Build the new software: To
build the new software, the
associated cost is ₹50,000.
 Buy the new software: To buy
the new software, the
associated cost is ₹75,000.
 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 ₹10,000.
Stay/Buy/Build
Decision
Build the New
Software
Cost:₹50,000
Stay With the
Legacy Software
Cost:₹10,000
Buy the New
Software
Cost:₹75,000

6.  The Buy the New Software and Build the New
Software options will lead to either a successful
deployment or an unsuccessful one. If the deployment is
successful then the impact is zero, because the risk will
not have materialized. However, if the deployment is
unsuccessful, then the risk will materialize and the
impact is ₹2lakh.
 The Stay with the Legacy Software option will lead to
only one impact, which is ₹2lakh, because the legacy
software is not currently meeting the needs of the
company. Nor, will it meet the needs should there be
growth.

7. Stay/Buy/Build
Decision
Build the New
Software
Cost:₹50,000
Successful
deployment
Cost:₹0
Unsuccessful
deployment
Impact:₹2lakh
Stay With the
Legacy
Software
Cost:₹10,000
Growth in
Business
Impact: ₹2lakh
Buy the New
Software
Cost:₹75,000
Successful
deployment
Cost:₹0
Unsuccessful
deployment
Impact:₹2lakh
100%
40%
5%

8. Calculating Expected Monetary Value for
each Decision Tree Path
 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.

9.  Build the new software: ₹ 2,00,000 * 0.4 = ₹ 80,000
 Buy the new software: ₹ 2,00,000 * 0.05 = ₹ 10,000
 Staying with the legacy software: ₹ 2,00,000 * 1 = ₹ 2,00,000
 Build the new software: ₹ 50,000 + ₹ 80,000 = ₹ 1,30,000
 Buy the new software: ₹ 75,000 + ₹ 10,000 = ₹ 85,000
 Staying with the legacy software: ₹ 10,000 + ₹ 2,00,000 = ₹
2,10,000
Now, add the setup costs to each Expected Monetary Value:

10. Conclusion
 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.