The_Essential_Manager_s_Handbook

MAKING DECISIONS / 211

Using decision charts

Creating a decision diagram or chart

can help you weigh up a number of

alternatives. For example, imagine you

are considering buying a house and have

found two options, one of which is more

expensive than the other. To buy house A,

you will need to borrow $300,000; to buy

house B, $500,000. You are concerned

about how much each of the houses will

cost you to buy over the lifetime of your

mortgage. To compare the two options,

first consider what the interest rates are

likely to be in the future. For example, you

may evaluate three possibilities: interest

rates rising to 10 percent, staying at the

current rate of 6 percent, and falling to

4 percent. Next estimate the percentage

chance of each change happening. For

both houses there is a 50 percent chance

of the rate remaining at 6 percent.

Now create your decision chart. To

calculate the expected cost, multiply the

annual mortgage cost by the percentage

chance for each interest rate and then

total the costs. The expected annual

mortgage cost for house A is $18,600

and $31,000 for house B.

Use this information to evaluate

your alternatives, but remember that

this is the average expected cost.

Averages very rarely happen, so you

also need carefully to assess risk, for

example, by asking yourself: “Can I

afford the house if the interest rates

are at 10 percent for a long period?”

BUY HOUSE B:

BORROW $500,000

Likely

interest rate

Annual

mortgage cost

Chance of

interest rate

Proportion

of cost

10% $50,000 20% $10,000

6% $30,000 50% $15,000

4% $20,000 30% $6,000

House B total expected annual mortgage cost: $31,000

US_210-211_Making_decisions.indd 211 31/05/16 5:29 pm