Walmart, as part of its sustainability program, installed speed governors which limit how fast trucks drive to save fuel. Of course, since trucks take longer to get to their destinations, more driver hours are required, which raises labor costs.

Suppose, prior to installing speed governors, Walmart used 141.2M gallons of fuel and 12.81M trucker hours. Average speed was 68 mph and fuel economy was 6.17 mpg.

After installing the governors, fuel use was 130.3M gallons and 13.82M trucker hours. Speed was 63 mph and fuel economy was 6.68 mpg.

Suppose further that truckers make $32 per hour and the price of fuel is $4 per gallon.

a. Assume Walmart wishes to hedge all fuel price risk by purchasing derivative securities. I have seen estimates that the cost of hedging is about 12-14% of the total fuel cost. Lets go with 12%. Calculate the total cost of hedging all fuel price risk before and after installing governors.

b. Calculate the total cost (fuel and labor, not hedging) before and after installing governors.

c. Calculate the change in total costs (T C) resulting from adopting speed governors, excluding hedging costs

d. Calculate the change in total costs (T C) resulting from adopting speed governors, including hedging costs.

e. An important driver of sustainability is production efficiency: minimizing use of costly resources like fuel, which are also harmful to the environment. Briefly discuss how adding risk management costs to production efficiency in a sustainability strategy affects the benefits of becoming more sustainable in this example.

f. Suppose there is a 10% of a carbon tax of $20/ton passing. Now, one gallon of diesel contains 22.4 lbs carbon, and of course 1 ton is 2000 lbs. The carbon tax will therefore show up here as an increase in the price of diesel, which is in dollars per gallon. Calculate the 10%VaR, both before and after speed governors, assuming no hedging.

g. Calculate the marginal cost of reducing the 10%VaR by $1 via installing speed governors. Hint: it should be negative!

h. Calculate the marginal cost of reducing the 10%VaR via hedging. Use the numbers from before speed governors were installed. Note: since the carbon tax shows up as an increase in the price of fuel, hedging against fuel price increases also hedges against a carbon tax.

i. Which is the best way to reduce risk, installing speed governors or hedging? Explain.