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IEMS 326 Notes08DecisionTrees

IEMS 326 Notes08DecisionTrees - Decision Trees IEMS 326...

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Decision Trees IEMS 326 Lecture 8
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Decision Trees Consider a small number of possible events. similar to scenario analysis Evaluate expected cashflow or NPV What would we do when we have choices? Models managerial flexibility Make the decision that maximizes NPV. Evaluation: Backward recursion computes NPVs at each node. Effect: pick the decision policy yielding the highest (expected) NPV.
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Conceptual: Enumeration Want to pick the decision policy yielding the highest (expected) NPV. Find cashflows for this decision policy d in each scenario i (which has probability p i ). Compute NPV V i (d) of d’s cashflows in each scenario i. Expected NPV of decision policy d is p 1 V 1 (d) + … + p n V n (d). Conceptually simpler, may take longer.
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How To: Backward Recursion Construct a tree, left to right, with branches . Some branches end in leaves ; leaves terminate. Some branches end in nodes which branch again.
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