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Decision tree

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA PM Exams › Decision tree

  • This topic has 3 replies, 2 voices, and was last updated 2 weeks ago by IAW3005.
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  • February 23, 2026 at 12:43 am #724830
    Prajnya
    Participant
    • Topics: 2
    • Replies: 1
    • ☆

    Hello Sir,
    Please help me understand the following question, I have come across a doubt in
    Kaplan Study text
    Decision tree- Value of imperfect Information example:

    (a) You have the mineral rights to a piece of land that you believe may have oil underground. There is only a 10% chance that you will strike oil if you drill, but the profit is $200,000.
    It costs $10,000 to drill. The alternative is not to drill at all, in which case your profit is zero.
    Should you drill? Draw a decision tree to represent your problem.
    (b) Before you drill, you may consult a geologist who can assess the promise of the piece of land. She can tell you whether the prospects are good or poor, but she is not a perfect predictor. If
    there is oil, the probability that she will say there are good prospects is 95%. If there is no oil, the probability that she will say prospects are poor is 85%.
    Draw a decision tree and calculate the value of imperfect information for this geologist. If the geologist charges $7,000, would you use her services?

    a)
    EV (‘Drill’) = ($190K × 0.1) + (–$10K × 0.9) so EV (‘Drill’) = $10K.
    We should drill, because the expected value from drilling is $10K, versus nothing for not drilling.

    b)We will calculate the Expected Value of profits if we employ the geologist.
    If this exceeds $10,000, the geologist would be worth employing as long as the benefit of employing her exceeds her charge of $7,000.
    assessments can be tabulated as follows (assume 1,000 drills in total):

    Oil present No oil Total

    Geologist says
    ‘Prospects are good’ 95% × 100 = 95 drills 15% × 900 =135 drills 230 drills

    Geologist says
    ‘Prospects are poor’ 5% × 100 = 5 drills 85% × 900 = 765 drills 770 drills

    100 drills 900 drills 1,000 drills

    A decision tree can be drawn to calculate the expected value of profits if a geologist is employed:

    Working from right to left:
    EV(A) = (41.30% × $200,000) – $10,000 drilling costs = $72,600.
    The decision at ‘C’ should be to drill, as this generates higher benefits than not drilling.
    EV(B) = (0.65% × $200,000) – $10,000 drilling costs = –$8,700. The decision at ‘D’ should be not to drill.
    EV(E) = 0.23 × $72,600 = $16,698. This is the expected value of profits if a geologist is employed and exceeds the EV of profits if she is not employed.
    Expected Value of Imperfect Information = $16,698 – $10,000 = $6,698.
    Since this is less than the cost of buying the information ($7,000), we should not employ the geologist at point ‘F’.

    Sorry, I couldn’t attach the decision tree diagram here. However, EV at Decision point E, only the probability and profit outcome of (A) is considered and (B) is not considered. I don’t understand why the EV multiplies only 0.23 * $72,600 but not 0.77* (–$8,700) “poor prospects” part? Please help me understand.

    Thanks!

    February 28, 2026 at 4:55 am #724910
    IAW3005
    Moderator
    • Topics: 4
    • Replies: 1604
    • ☆☆☆☆☆

    As explained in the lectures on this, you cannot now be expected to draw a decision tree in the exam (although you can be tested that you understand decision trees).

    The answer to part (b) must start with the results from the geologist, because what she says will affect the decision about whether or not to drill.

    March 1, 2026 at 12:17 am #724925
    Prajnya
    Participant
    • Topics: 2
    • Replies: 1
    • ☆

    Thanks for the response!

    March 2, 2026 at 10:25 pm #724981
    IAW3005
    Moderator
    • Topics: 4
    • Replies: 1604
    • ☆☆☆☆☆

    Your welcome

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