Summary
Summary LU6: Expected value theory and decision trees
- Course
- Institution
- Book
A summary on LU6: Expected value theory and decision trees
[Show more]
Connected book
Book Title:
Author(s):
- Edition:
- ISBN:
- Edition:
More summaries for
-
LU5: Relevant costs
-
LU3: Cost-volume-profit Analysis
-
LU1: Budgeting and Standard Costing
Seller
Follow
luthandozulu
Reviews received
Content preview
Luthando Zulu: 17599770Finance 2B – FINM6212
LU6: Expected value theory and decision trees
Introduction:
Due to the nature of the business world, most decisions have to be made under conditions of uncertainty.
The theories of expected value and decision trees are designed to assist with decision-making under
these circumstances.
Below is a list of definitions that will be used in this learning unit:
Expected value Sum of the weighted values associated with a decision.
Certainty Circumstances where all the outcomes are known. This means that the decision-
maker is in possession of perfect information. Decision making is without risk.
Uncertainty These refer to circumstances where the outcome is unknown, and the probabilities
of the possible outcomes cannot be assigned. This means that the decision maker
is in possession of imperfect information. Decision-making can, therefore, carry
some form of risk.
Risk Refers to the probability of damage, liability or other negative consequences
arising from internal or external vulnerabilities which may be mitigated through
proactive risk management.
Probability The likelihood that an event, condition or outcome will occur.
Attitude towards risk:
Individuals and decision-makers, by their nature, will have different attitudes toward risk.
Individuals have one of three attitudes when it comes to risk:
Risk taker An individual who is fearless of risk and
uncertainty and is willing to take a chance in the
hope of achieving a highly favourable outcome.
Risk averter An individual who is fearful of risk and prefers a
more certain outcome.
Risk neutral An individual who is indifferent to alternatives that
yield an equal return and will vouch for the
alternative that yields a higher average profit in
the long-term.
Expected value theory:
A mathematical tool that considers the possible outcomes as well as the probability of occurrence of each
alternative presented to management in the decision-making process. The expected value of a decision is
the sum of the weighted values outcomes associated with a decision. The weightings represent the
probabilities that each outcome will occur.
The expected value formula is calculated as follows:
EV =∑ (Pr ¿ ¿1 x value1)+(Pr ¿ ¿ 2 x value2 )+(Pr ¿ ¿ 3 x value3 ) …+(Pr ¿ ¿ n x value n )¿ ¿ ¿ ¿
1
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller luthandozulu. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $14.13. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
50843 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now