DEFINITION of 'Tree Diagram'

A diagram used in strategic decision making, valuation or probability calculations. The diagram starts at a single node, with branches emanating to additional nodes, which represent mutually exclusive decisions or events. In the diagram below, the analysis will begin at the first blank node. A decision or event will then lead to node A or B. From these secondary nodes, additional decisions or events will occur leading to the third level of nodes, until a final conclusion is reached.

Tree Diagram

BREAKING DOWN 'Tree Diagram'

Using the diagram is simple once you assign the appropriate values to each node. Chance nodes, representing a possible outcome, must be assigned a probability. Decision nodes ask a question and must be followed by answer nodes, such as "yes" or "no". Often, a value will be associated with a node, such as a cost or a payout. Tree diagrams combine the probabilities, decisions, costs and payouts of a decision and provide a strategic answer.

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