TUTORIAL
TWO
DECISION
TREES FOR LAWYERS
By
Michael D. Freeborn
In
this tutorial, let's get real! Whoever heard of litigation that
didn't involve legal fees? So let's assume now the same facts as in the
first tutorial, but also assume legal fees of $150,000 will be incurred by the
company if the case is not settled.
What's your decision now? Litigate or Settle?
The diagram at the right looks like the original diagram, but you will see
that legal fees are now included on the branch of the decision tree which
follows the decision to litigate.
Note that we move from left to right along each path of the tree. For
each path, we are going to calculate an "expected cost." We
add or subtract all the benefits or costs, respectively, and then multiply
this sum by the product of multiplying all the chance percentages encountered along the way.
So once we decide to litigate, we incur $150,000 in legal
fees regardless whether we win or lose. Even if we win we are out that sum,
and we assumed in the earlier example that there was a 50-50 chance of that
happening. Thus, the "expected cost" of just that path is
(-$150,000)x(.5) or -$75,000. To this we
must add the expected cost of the next path, losing after a decision to litigate. This
is (-$150,000-$1,000,000)x.5 or -$575,000.
Thus our expected cost of the decision to "Litigate" is now a total
of (-$75,000-$575,000) or -$650,000. The expected cost of
"Litigate", after taking into account $150,000 in legal fees,
exceeds the known cost to "Settle" -- $600,000 -- so settlement
makes sense.
Easy enough? Let's go on to Tutorial 3 !
(Or would you prefer to go back to the Introduction
or Tutorial 1
?)
Copyright © 2001 Michael D. Freeborn. All rights reserved.
