Savannah Products, a small integrated wood and lumber products company with substantial timber holdings, has two divisions: Forest and Lumber. Forest Division manages the timber holdings, maintains the land, and plants and harvests trees. It acquired its various forests over the last 50 years; its total asset value as stated on Savannah’s balance sheet is $2.2 billion. Most of the timber the Forest Division harvests is sold internally to the Lumber Division. Any harvested timber not sold to the Lumber Division can be sold externally. Last year, the Forest Division sold 200 million board feet of timber to external customers at $4.50 per board foot. A board foot is a standard unit of measure in the timber business. Forest Division sold another 800 million board feet of timber to the Lumber Division.
The Forest Division’s operating expenses last year totaled $2 billion.
The Lumber Division only purchases timber from the Forest Division. The purchase price is computed as Lumber’s share of Forest’s operating expenses where the share is based on Lumber’s fraction of Forest’s total board feet harvested. Lumber takes the timber from Forest, cuts it into lumber, and sells it to distributors. Lumber’s total revenues, other operating expenses, and assets are $7.6 billion, $3.5 billion, and $2.7 billion, respectively. Lumber’s operating expenses of $3.5 billion do not include its pro rata share of Forest’s operating expenses.
Savannah Products uses economic value added (EVA) to evaluate and reward the performance of the senior managers in the two divisions. The risk-adjusted weighted-average cost of capital for the Forest and Lumber Divisions is 15 percent and 20 percent, respectively.
Required:

a. Calculate the EVA of the Forest and Lumber Divisions.

b. Based on your calculations in (a), identify the most profitable division.

c. Do the calculations in

(a) correctly identify the most profitable division? Explain why or why not.

d. What changes would you recommend Savannah Products make in its performance measurement scheme?