Decision-tree Approach

The Decision-tree Approach (DT) is another useful alternative for evaluating risky investment proposal. The outstanding feature of this method is that it takes into account the impact of probabilistic estimates of potential outcomes. In other words, every possible outcome is weight in probabilistic terms and then evaluated. The DT approach is especially useful for situations which decisions at one point of time also affect the decisions of the firm at some later Another useful application of the DT approach is for projects which require decisions to be in sequential parts.

A decision tree is a pictorial representation in tree form which indicates the magnitude probability and inter relationship of all possible outcomes ? The format of the exercise of investment decision has an appearance of a tree with branches and, therefore, this method referred to as the decision-tree method. A decision tree shows the sequential cash flows and NPV of the proposed project under different circumstances.

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