Investment Decision Based on Probability Discussion Assignment

Investment Decision Based on Probability Discussion Assignment

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Investment Decision Based on Probability Discussion Assignment

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Kennedy Trucking Company (Investment Decision Based on Probability

Kennedy Trucking Company (investment decision based on probability analysis) (LO1) Five years ago, Kennedy Trucking Company was considering the purchase of 60 new dieseltrucks that were 15 percent more fuel-efficient than the ones the firm is now using. Mr.

Hoffman, the president, had found that the company uses an average of 10 million gallons of diesel fuel peryear 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 cannotcontrol and that any increased costs of fuel will be passed on to the shipper through higher ratesendorsed by the Interstate Commerce Commission. If this is true, then fuel efficiency would savemore money as the price of diesel fuel rises (at $1.35 per gallon, he would save $2,025,000 intotal if he buys the new trucks). Mr. Hoffman has come up with two possible forecasts shownbelow—each of which he feels has about a 50 percent chance of coming true.

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Under assumption number 1, diesel prices will stay relatively low; under assumption number 2, diesel prices willrise considerably. Sixty new trucks will cost Kennedy Trucking $5 million. Under a specialprovision from the Interstate Commerce Commission, the allowable depreciation will be25 percent in year 1, 38 percent in year 2, and 37 percent in year 3. The firm has a tax rate of40 percent and a cost of capital of 10 percent.a.First compute the yearly expected price of diesel fuel for both assumption 1 (relativelylow prices) and assumption 2 (high prices) from the forecasts below.Forecast for assumption 1 (low fuel prices):

B what will the dollar savings in diesel expenses for 1 year for assumption 1 and assumption 2

Investment Decision Based on Probability Discussion Assignment

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