7. The Process Expand by opening new outlet Maintain current status Economic growth rises Economic growth declines 0.7 0.3 Expected outcome ÂŁ300,000 Expected outcome -ÂŁ500,000 ÂŁ0 A square denotes the point where a decision is made, In this example, a business is contemplating opening a new outlet. The uncertainty is the state of the economy â if the economy continues to grow healthily the option is estimated to yield profits of ÂŁ300,000. However, if the economy fails to grow as expected, the potential loss is estimated at ÂŁ500,000. There is also the option to do nothing and maintain the current status quo! This would have an outcome of ÂŁ0. The circle denotes the point where different outcomes could occur. The estimates of the probability and the knowledge of the expected outcome allow the firm to make a calculation of the likely return. In this example it is: Economic growth rises: 0.7 x ÂŁ300,000 = ÂŁ210,000 Economic growth declines: 0.3 x ÂŁ500,000 = -ÂŁ150,000 The calculation would suggest it is wise to go ahead with the decision ( a net âbenefitâ figure of +ÂŁ60,000)
8. The Process Expand by opening new outlet Maintain current status Economic growth rises Economic growth declines 0.5 0.5 Expected outcome ÂŁ300,000 Expected outcome -ÂŁ500,000 ÂŁ0 Look what happens however if the probabilities change. If the firm is unsure of the potential for growth, it might estimate it at 50:50. In this case the outcomes will be: Economic growth rises: 0.5 x ÂŁ300,000 = ÂŁ150,000 Economic growth declines: 0.5 x -ÂŁ500,000 = -ÂŁ250,000 In this instance, the net benefit is -ÂŁ100,000 â the decision looks less favourable!