3.2 Payoff value

The payoff value is equivalent to the net profit (or net loss) expected at the end of any outcome. Write payoff values at their respective branch endpoints. Although you can express payoff in various ways, it is common to use monetary units in most business applications.

Payoff is the difference between investment cost and gross revenue. This primer adopts the convention of indicating investment costs as negative values to simplify calculating payoff values.

Payoff values can be positive or negative. Negative payoff values indicate a net loss.

Figure 3.2


Figure 3.2 shows the expected payoffs at two endpoints. The fixed-yield investment results in $1,050,000 revenue, and therefore a $50,000 payoff. The payoff for doing nothing is $0. The other branches lead to chance nodes at this stage of the decision tree. You can assign payoff values only after these chance nodes lead to endpoints.

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