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I think you ought to run the pipe and then start the generator without the muffler. I think you will surprised at how quiet then exhaust is. Just go with a pipe and a cap. Now inside the shed you will need serious hearing protection. Also make sure you have adequate ventilation for the cooling...

It already has a muffler. The noise you are hearing is not exhaust noise, it is engine noise. The fan, generator and the fact it is a diesel just make it noisy. If you stand in line with the exhaust outlet when it starts you will see that the exhaust is rather quiet.