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Five years ago, a company was considering the purchase of 68 new diesel trucks that were 14.63% more fuel-efficient than the ones the firm is

Five years ago, a company was considering the purchase of 68 new diesel trucks that were 14.63% more fuel-efficient than the ones the firm is now using. The company uses an average of 10 million gallons of diesel fuel per year at a price of $1.25 per gallon. If the company manages to save on fuel costs, it will save $1.875 million per year (1.5 million gallons at $1.25 per gallon). On this basis, fuel efficiency would save more money as the price of diesel fuel rises (at $1.35 per gallon, the firm would save $2.025 million in total if he buys the new trucks).

Consider two possible forecasts, each of which has an equal chance of being realized. Under assumption #1, diesel prices will stay relatively low; under assumption #2, diesel prices will rise considerably. The 68 new trucks will cost the firm $5 million. Depreciation will be 25.49% in year 1, 38.5% in year 2, and 36.35% in year 3. The firm is in a 39% income tax bracket and uses a 9% cost of capital for cash flow valuation purposes. Interest on debt is ignored. In addition, consider the following forecasts:

Forecast for assumption #1 (low fuel prices):

Price of Diesel Fuel per Gallon

Prob. (same for each year)

Year 1

Year 2

Year 3

0.1

$0.8

$0.91

$1.01

0.2

$1.02

$1.12

$1.09

0.3

$1.12

$1.22

$1.32

0.2

$1.31

$1.45

$1.47

0.2

$1.4

$1.55

$1.61

Forecast for assumption #2 (high fuel prices):

Price of Diesel Fuel per Gallon

Prob. (same for each year)

Year 1

Year 2

Year 3

0.1

$1.23

$1.53

$1.72

0.3

$1.31

$1.7

$1.99

0.4

$1.83

$2.32

$2.5

0.2

$2.22

$2.52

$2.81

Required: Calculate the percentage change on the basis that an increase would take place from the NPV under assumption #1 to the probability-weighted (expected) NPV.

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