Week 4 Critical Thinking (PMJ410)

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Colorado State University, Global Campus *

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410

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Economics

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Apr 3, 2024

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docx

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New Versus Used Car Decision Tree Alfred Lewis Pemberton III Colorado State University Global PJM410-1: Assessing and Managing Risk Dr. Durham February 11, 2024
New Versus Used Car Decision Tree Large purchases can be nerve wracking, and making a decision that will cost you thousands is something you don’t want to do impulsively. Today I will create a decision tree to help me decide wether buying new versus used is right for me when it comes to car shopping. There are many variables when it comes to deciding to purchase a car. From the color you want, make, model, and of course the year there are a lot of choices. For many, buying a new car is ideal because you have the piece of mind knowing the history of the vehicle you’re buying. Obtaining a vehicle is a large investment, and not everyone can afford to buy a car brand new. I think most can agree that one of the biggest concerns when purchasing a used car is the potential need for repairs and the unknown of the car's previous history with prior owners. Using my decision tree, I will make a decision choosing the lower investment cost. Car Buying Information The purchase price for a new car is $15,000 while the cost to purchase a used car is $7,500. There is a 90% chance that the new car will not need any repairs, whereas the used car has a 40% chance of needing repairs. The outcome of those repairs for each would cost me $5,000 for the new car versus $9,000 to repair the used car. Just by this information I may want to quickly decide to buy the new car because I like the sound of only a 10% chance of needing repairs within a one-year period, but sometimes looks can be deceiving. Using this information, I’ve created a decision tree to determine the lowest investment cost required for each vehicle. Decision Tree Results A decision tree shows how to decide between alternative capital strategies when the environment contains uncertain elements (PMI, 2017). Magee (2014) noted that these decision trees do not give the answers to an investment problem, but it helps to determine which alternative at any particular choice point will provide the "greatest expected monetary gain" with the given information and the alternatives pertinent to the decision. Detailed under Appendix A is a decision tree diagram analyzing the options of a new or used car. A tool that can be helpful in decision making is the decision tree analysis technique that is calculated using expected monetary value (EVM) by multiplying the probability of each chance by the result to determine its value (Hulett, D.T., 2006). The formula I utilized to determine this value is ‘Probability x
Impact = Expected Monetary Value’. Before the EVM for each choice can be calculated, the Net Path Value (NPV) must be found by subtracting the cost of your decision from the path outcome. Using the used car as an example, (reference Appendix A), finding the NPV is as follows: No repairs needed – -$7,500 - $0 = -$7,500 Repairs needed – -$7,5000 - $9,000 = -$16,500 Now that the NPV has been calculated, I can use those sums to find the EMV for each decision node. With the used car there is a 60% chance of no repairs needed and a 40% chance of it needing repairs costing $9,000 within the first year. The EVM formula looks like this: .40(-$7,500) + .40(-$16,500) = -$11,100 As shown in the decision tree, (reference Appendix A), the estimated value of the new car is - $15,500 which makes the purchasing of the used car with and EVM of -$11,100 the lowest investment cost of the two choices. Conclusion A decision tree is an amazingly helpful tool to examine your decision choices in an organized, well planned out way. By utilizing a decision tree in my decision making today, I know the used car would be the best choice when comparing used versus new car purchases. Purchasing the used car at $7,500 would be the lower investment even with the 40% chance it will need repairs in the first year of use.
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