Business Management – SL

Business Management Toolkit – Decision Tree

DECISION TREE DRILLING

Answer all these questions on your own paper!

Choose between Alternative A or B! [3 marks]

2. Drisner Traders Ltd. is considering a move into overseas markets. The Australian company is deciding
between two locations: Kazakhstan or South Korea. Market research results are shown in the table below.
All financial figures are expressed in $ for ease of comparison
Kazakhstan Probability Cost/Revenue ($)
Cost 250,000
High return 0.6 400,000
Low return 0.4 250,000

South Korea Probability Cost/Revenue ($)

a) Construct a decision tree to show which of the two locations is best for Drisner Traders Ltd., based on
financial grounds! [5 marks]
b) Discuss the value of decision trees as a decision-making tool Drisner Traders Ltd! [10 marks]
3. Choose between Subcontract, Expand, or Build! [6 marks]

4. Evgenii Gvozdev Beverages (EGB) produces traditional Russian herbal drinks. The company’s product are
well known in Moscow and neighboring cities in Russia, the only country it currently operates. With
secondary market research data suggesting that sport and exercise are becoming increasingly popular, EGB
is considering entering the market for energy drinks.
The success of the proposal is largely dependent on the level of economic growth in the region over the
next five years. EGB is considering several options to expand overseas, although the company can only
afford to implement one of these initially. The estimated costs and benefits of the options are shown below:
Option Economic growth Chance (%) Return ($m) Cost ($m)
Kazakhstan Improve 50 16
Unchanged 30 10 10.6
Worsen 20 4
Latvia Improve 60 18
Unchanged 30 8 9.8
Worsen 10 2
Belarus Improve 40 18
Unchanged 30 7 11.3
30 (2)
a) Define the term secondary market research [2 marks]
b) Construct a fully labeled decision tree and calculate the predicted outcome for each option faced by
EGB [5 marks]
5. Mitrovska Educational Resources (MER) is considering expanding into one of three locations. The expected
costs and revenues are shown in the table below. the Chief Financial Officer, Sanja Mitrovska, has made it
clear that the company only funds to pursue one of these growth options.
Project Probability (%) Cost ($m) Revenue ($m)
Macedonia 100
Success 50 215
Failure 50 80
Bulgaria 80
Success 65 180
Failure 35 75
Serbia 90
Success 60 175
Failure 40 90
a) Using the information above, construct a decision tree diagram showing which project MER should
pursue. Show all your working out and include an appropriate key for your diagram [6 marks]
6. The manager of an events-organising business has to decide between holding a fund-raising auction indoors
or outdoors. The financial success of the event depends not only on the weather, but also on the decision
to hold it indoors or outdoors. Which one would you recommend?

7. The owner of a service station is planning to expand the business. The two options are to build a
forecourt to sell petrol or to construct a showroom to sell cars. The estimated building costs are: petrol
forecourt – $100000; car showroom – $150000. The forecast economic consequences or pay-offs during
the expected lives of these investments will depend on the level of demand in the economy, as shown
in the table below. The probability of demand being low during the life span of these investments is 0.2
and the probability of high demand is 0.8.
Demand Petrol forecourt ($) Car showroom ($)
High 500,000 800,000
Low 400,000 200,000
a) Show these options on a decision tree, adding the pay-offs and probabilities. [6 marks]
b) Calculate the expected value of both investments and recommend which option should be taken. [6
marks]
c) State three other factors that you consider might influence the business owner’s final decision [3
marks]
8. Joe Keenan had an important decision to take. He operated a mobile market stall selling cooking pans
and kitchen equipment. He has to decide which market to visit next Saturday. There are four options
but, of course, he can only go to one town. He has estimated the revenues he could earn from each
location by using past records and by consulting with other stallholders. His estimates in dollars ($),
together with the chances of earning them, are given below:
Town A Town B Town C Town D
Revenue Revenue Revenue Revenue
Probability Probability Probability Probability
($) ($) ($) ($)
0.4 5,000 0.3 3,000 0.4 3,000 0.3 5,000
0.6 8,000 0.5 4,000 0.5 6,000 0.3 6,000
0.2 8,000 0.1 10,000 0.4 9,000
a) Using the data above draw a decision tree of the options Joe has and add the probabilities and
forecasted economic returns. [6 marks]
b) Calculate the expected values of the four options that Joe has. Which town market should Joe visit
on Saturday on the basis of quantitative data alone? [10 marks]
c) Explain three factors that could influence the accuracy of Joe’s forecasts. [6 marks]

9. After a period of consolidation in 2008–9, when the Four Seasons leisure group saw a big contraction in
demand due to the world economic slowdown, the company is looking to increase its share of the
upmarket, all-inclusive holiday resort market. Thirty years of providing holidays to high-income European
and North American consumers make Four Seasons Leisure one of the most prestigious brands in the
Caribbean.
Despite the recession, the company performed fairly well in 2009. Profits fell 5%, but this compared
favorably with an industry average profit decline of 9%. Four Seasons has attributed the group’s relative
success to effective management from a team of people that have considerable knowledge and expertise
in the market.
The management team is not complacent, however. The chief executive officer, Austin Walsh, thinks the
company’s concentration in the Caribbean is a weakness because of competition from new holiday
destinations such as Dubai. Austin believes the company needs to expand into some of the new
destinations that its customers are interested in visiting. The directors are considering three options for
2013:
Projected profits based on economic conditions
($m)
Initial cost Normal
Fast growth Recession
($m) growth
Open new
Option 1 120 400 200 -100
resort in Dubai
Open new
Option 2 resort in 150 500 300 -50
Thailand
Upgrade
existing
Option 3 80 150 120 100
resorts in
Carribean
The consultancy that produced the projected costs and profit data believe that there is a 20% chance of
fast economic growth, 50% chance of normal economic growth and a 30% chance of a recession.
a) Construct a fully labelled decision tree showing Four Seasons’ options. [5 marks]
b) Calculate the expected values for each option. [6 marks]
 c) On financial grounds state which option Four Seasons should choose. [2 marks]
d) Analyse one weakness for Four Seasons of using decision tress as a basis for making this business
decisions. [4 marks]

10. Choose between Option 1 or Option 2!