To adjust your timing, you'll need the dial indicator and special ve pump fixture to hold it. Advancing the timing will do a couple good things, such as improve mileage, reduce smoke, and usually gives you more crisp throttle response (compaired to retarded timing). 2.5" exhaust would be nice, but the stock size isn't any smaller that the turbo outlet to begin with. If your not looking to make more power, just removing the mufflers should be fine to help it breathe. As I said, you can always install another just make sure its a diesel muffler.
Here is the timing adjustment procedure:
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Jason