Decision Tree

Decision Tree

Introduction

Background

Some introductory terms such as Decision Making and Risk are explained:

Decision Making

Decision making in project management is a problem-solving process. The project manager makes decisions to face and solve the problems and challenges. The logic of this process is quite simple. After the identification of the problem, a decision needs to be made only if there are different alternatives or different solutions. If there is also one solution, the project manager tries to consider all the implications that will occur from this solution. If there are more than one different alternatives, the project managers try to make the decision that will lead the project and the company into prosperity. Moreover, these decisions must be made in timely fashion.

Risk

Risk can be defined as the expected consequences derived from a given activity.

Considering an activity with only one event with potential conse

Decision Tree

Purpose

Decision Tree is a graphical method for illustrating the flow of decisions faced on a project depending on the possibility of each decision. A decision on a project cannot be considered as a single, isolated occurrence, but instead as an outcome of several interrelated decisions. Decision Tree is a mathematical modelling technique, used as a Risk Analysis and Management Tool. Through it, the project managers can observe options, which can be used for decision making and management of the project. The Decision Tree can assist them with probabilistic cost estimation of a project, incorporating risks of uncertain events, which may happen, and supply of alternative options and scenarios. Despite, some limitations and challenges faced by its application, decision tree analysis displays a powerful quantitative technique for different future alternatives, taking into account not only probability, but also choice.

Structure

Decision trees are quantitative diagrams with nodes and branches representing different possible decision paths and chance events. The decision tree is read from left to right. More specifically, a decision tree consists of the following elements

• Root node: It is the leftmost node of the decision tree
• Decision node: It is represented by a small square.
• Decision tree branches: These branches which emanate from the right side of the decision nodes, compose the set of alternative decisions – solutions, which can be pursued. The project manager can select and put into application, one and only of these branches.
• Chance node: Chance nodes are represented by small circles in the decision tree, indicate that a chance event is expected at that point. The number, which can be seen on the branch of each of these nodes, presents the probability of the decision on each branch to occur in the chance node.
• Endpoint: The right end of each path of the decision tree is named as endpoint. Every endpoint in the decision tree shows the final outcome of following this particular path from the root node to this particular point.

Construction of decision tree

For an accurate construction of a decision tree, a project manager needs to conduct the following steps

• Construction of a logic tree, usually from left to right, including the decision and chance nodes
• Addition of the probabilities of the different states on the branches of the tree. The logic tree is, therefore, transformed into a probability tree. Caluclation of the probabilities in the endpoints. The sum in the probabilities in the endpoints must be equal to one.
• Addition of the conditional outcomes. The construction of decision tree is completed.

Decision Tree Analysis

Figure 1: Decision Tree Analysis

Example

A decision has to be taken whether the company should fund project X or project Y, as it can be seen from the Figure X. Each project has two possible outcomes. Project X has a 75 percent chance of yielding 100000 monetary value, but also a 25 per cent chance of only yielding 20000. Project Y has a 50 per cent chance of yielding 200000 and 50 per cent of chance that profit will be zero. Figure X illustrates the current decision problem.

The company in this case tries to maximize its expected value (or in the opposite condition to minimize its expected costs). The final decision is made through the sum of the expected values of the yields of each branch.

For project X

Limitations of Desicion Tree Analysis

Decision Tree Analysis has some inherent limitations in its application, as

• Inadequacy in applying regression and predicting continuous values
• Possibility of false relationships

Annotated bibliography

1. Winch, G. M. (2010), "Managing Construction projects". Second edition

Summary: The book presents a holistic approach of construction management. The basic principles of construction project management are presented along with different tools and techniques that aims to enhance construction performance and provide innovative techniques. The use of information and communication technologies is also a point of interest in the book.

2. Kerzner, H., Ph.D., (2006), "Project Management: A systems approach to planning, scheduling and controlling". Ninth edition

Summary: The book illustrates the basic principles of project management. The book is targeting for enhancing the project skills of not only students, but also executives, pointing out that project management can be related to every profession apart from engineeering, including information systems and business.

3. Maylor, H. (2010), "Project Management". Fourth Edition

Summary: This book cover all the topics of project management, focusing in the theory, as well as in the application and usage of the ideas discussed in it. The book points great emphasis into the 4D-model of the project.

4. Flyvbjerg, B. (2008) "Curbing Optimism Bias and Strategic Misrepresentation in Planning": Reference Class Forecasting in Practice, European Planning Studies Vol. 16, No. 1

Summary: This paper presents the method and illustrates the first instance of reference class forecasting. The paper targets in the inaccuracy of the financial appraisal in planning in construction, explains them in terms of optimism bias and strategic representation and present a method of eliminating this inaccuracy.