Decision

RELEVANT TO ACCA QUALIFICATION PAPER F5

Decision trees

The addition of decision trees to the Paper F5 syllabus is a relatively recent one that probably struck fear in the heart of many students. To be honest, I don’t blame them for that. When I first studied decision trees, they had a similar effect on me: I hated them and just didn’t fully understand the logic. The purpose of this article is to go through a step-by-step approach to decision trees, using a simple example to guide you through. There is no universal set of symbols used when drawing a decision tree but the most common ones that we tend to come across in accountancy education are squares (□), which are used to represent ‘decisions’ and circles (○), which are used to represent ‘outcomes.’ Therefore, I shall use these symbols in this article and in any suggested solutions for exam questions where decision trees are examined. Decision trees and multi-stage decision problems A decision tree is a diagrammatic representation of a problem and on it we show all possible courses of action that we can take in a particular situation and all possible outcomes for each possible course of action. It is particularly useful where there are a series of decisions to be made and/or several outcomes arising at each stage of the decision-making process. For example, we may be deciding whether to expand our business or not. The decision may be dependent on more than one uncertain variable. For example, sales may be uncertain but costs may be uncertain too. The value of some variables may also be dependent on the value of other variables too: maybe if sales are 100,000 units, costs are $4 per unit, but if sales are 120,000 units costs fall to $3.80 per unit. Many outcomes may therefore be possible and some outcomes may also be dependent on previous outcomes. Decision trees provide a useful method of breaking down a complex problem into smaller, more manageable pieces. There are two stages to making decisions using decision...