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Decision Trees Example

The document outlines a decision-making scenario involving three options for software: building new software, buying new software, or staying with legacy software. It calculates the Expected Monetary Value for each option, revealing that buying new software, despite its higher initial cost, is the most cost-efficient choice, while staying with legacy software is the most expensive. The analysis illustrates the use of Decision Trees in project risk management to evaluate costs and impacts associated with each decision.

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muluneh paulos
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20 views3 pages

Decision Trees Example

The document outlines a decision-making scenario involving three options for software: building new software, buying new software, or staying with legacy software. It calculates the Expected Monetary Value for each option, revealing that buying new software, despite its higher initial cost, is the most cost-efficient choice, while staying with legacy software is the most expensive. The analysis illustrates the use of Decision Trees in project risk management to evaluate costs and impacts associated with each decision.

Uploaded by

muluneh paulos
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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 Decision Trees Example - Building the Decision Tree to Use in Decision Tree Analysis

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.
Looking at the options listed above, you can start building the decision trees as shown in the
diagram. By looking at this information, the lobby for staying with the legacy software would
have the strongest case. But, let’s see how it pans out. Read on.
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 $2 million. The Stay with the Legacy Software option
will lead to only one impact, which is $2 million, because the legacy software is not currently
meeting the needs of the company. Nor, will it meet the needs should there be growth. In this
example, we have assumed that the company will have growth.
In this example, Decision Trees analysis will be used to make the project risk management
decision. The next step is to compute the Expected Monetary Value for each path in the Decision
Trees. Let's see how this helps in this Decision Trees example.

 Decision Trees Example - 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. 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
View the image above, to see how all the figures above look like in a Decision Tree after
conducting a Decision Tree Analysis. Now let's make the decision in this Decision Trees
example. This will illustrate the role of Decision Trees in Project Risk Management.

 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.

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