2024 – Please help with the attached problem Please provide detailed solutions for each question Accounting Problem doc Five

Five years ago, Kennedy Trucking Company was considering the purchase of 60 new
diesel trucks that were 15 percent more fuel-efficient than the ones the firm was using.
Mr. Hoffman, the president, had found that the company uses an average of 10 million
gallons of diesel fuel per year at a price of $1.25 per gallon. If he can cut fuel
consumption by 15 percent, he will save $1,875,000 per year (1,500,000 gallons times
$1.25).
Mr. Hoffman assumed that the price of diesel fuel is an external market force that he
cannot control and that any increased costs of fuel will be passed on to the shipper
through higher rates endorsed by the Interstate Commerce Commission. If this is true,
then fuel efficiency would save more money as the price of diesel fuel rises (at $1.35 per
gallon, he would save $2,025,000 in total if he buys the new trucks). Mr. Hoffman has
come up with two possible forecasts as shown below——each of which he feels has
about 50 percent chance of coming true. Under assumption number 1, diesel prices will
stay relatively low; under assumption number 2, diesel prices will rise considerably. Sixty
new trucks will cost Kennedy Trucking $5 million. Under a special provision from the
Interstate Commerce Commission, the allowable depreciation will be 25 percent in year
1, 38 percent in year 2, and 37 percent in year 3. The firm has a tax rate of 40 percent and
a cost of capital of 10 percent.
a) First compute the yearly expected costs of diesel fuel for both assumption 1
(relatively low prices) and assumption 2 (high prices) from the forecasts below.
Forecast for assumption 1 (low fuel prices)
Probability (same
for each year)
.1
.2
.3
.2
.2

Year 1

Year 2

Year 3

$.80
1.00
1.10
1.30
1.40

$.90
1.10
1.20
1.45
1.55

$1.00
1.10
1.30
1.45
1.60

Forecast for assumption 2 (high fuel prices):
Probability (same
for each year)
.1
.3
.4
.2

Year 1

Year 2

Year 3

$.1.20
1.30
1.80
2.20

$1.50
1.70
2.30