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INTRODUCTION

years, the company continues


is considered as to invest in growth programs
one of the most and brand building
leading multinational throughout the portfolio. Its
companies in the world and is capital budgeting decisions
ranked among the top ten regarding research and
U.S. Companies in patents development and other
granted. In the array of capital expenditures are
thousands of products, 3M hoped to increase in every
products are considered to be coming year which requires
the most innovative. 3M the challenges of meeting
produces more than 200 growing needs for finances,
innovative products each efficient allocation of
year. With a ticker symbol of resources, making good
MMM, It is listed on the New investment decisions and
York, Pacific, Chicago and most importantly maintaining
Swiss stock Exchange. a balance between the
objective of profit and
3M, established in 1902, now
operates in more than 60
countries and is engaged in
producing more than 75,000
products including adhesives,
sand paper, post-it products,
abrasives, pharmaceuticals,
fluorochemicals, optics,
coatings, ceramics, LCDs,
cables and other industrial shareholder’s wealth
and office equipments. It is maximization. It has to have
said that a quarter of the a competitive edge and
world’s population uses one maintain itself financially
or more 3M products daily sound and stable in
and its demand for the accordance with the growing
products is increasing day by global demand of its products
day leading the company to and increasing innovation in
make solid sales growth and the world.
make further prosperity in WHY CAPITAL
future. BUDGETING DECISIONS
ARE IMPORTANT?
With referring to the
organizational growth and
success over the past few Capital
Budgeting
decisions are the most because they involve risk and
important and critical understanding of uncertainty
decisions that directly about each investment and
influence the company’s project, which is usually
performance in terms of difficult to analyze.
profitability and liquidity.
These decisions can lead the
company to reach the heights
of success and can even lead
the company to face disaster.
So effective capital budgeting
decisions are key to the
organizations’ success

Case study

OVERVIEW / ANALYSIS

Since 3M makes almost 60% ofinitsthe year 2006. 1A brief overview


revenue from international marketsabout the company’s capital
that’s why its primary growth strategy
budgeting activities over the past few
is based on continuing international
years is given below:
expansion and producing more
innovative products into new • orIn 2005, 3M spent about $26
existing markets. Currently 3Mmillion for capital projects related
manages its business operations in sixto protecting the environment
business segments i.e. Health care,which are further expected to
Industrial and Transportation, Displayincrease to $35 million for new
and Graphics, Consumer and Office,programs to build pollution
Electro and communication, Safetycontrol devices, modern facilities
security and protection services. and modify manufacturing
3M’s FINANCIAL MANAGEMENT processes to minimize waste and
STRUCTURE IN TERMS OF reduce emissions.
CAPITAL BUDGETING DECISIONS

3M’s capital budgeting decisions are


mostly related to its R&D, •
acquisitions, strategic alliances,
mergers, investments in plant, •
property, equipment and usually in
available for sale securities.3M • In 2005, 3M announced to
invests more than $1 billion per year build an LCD optical film
in research and development and manufacturing facility in
related activities, and is awarded
nearly 600 U.S. patents each year.1
3M’s capital expenditures totaled Only few of the material
investments have been mentioned in
$943 million in 2005 and arethe analysis to give the readers idea
expected to increase up to $1.1 billionabout the company’s capital
budgeting activities.
Poland in order to cater to the continued to buy 100% of
LCD-TV market in Europe outstanding shares from
and to better serve its various companies,
customers. manufacturing lines and
subsidiaries for the purpose
of expansion
and other
activities.

• In 2006,
company
combined its
industrial
and

transportation business
• In 2005, 3M (industrial segment to increase
business segment) acquired a efficiency and lower down its
CUNO filtration plant for operational costs.
purification of fluid and
gases for $1.36 billion ($1.27• In 2005, approximately $3.6
billion paid in cash and $80 billion of cash was used to
million of debt out of which repurchase 3M common
mostly has been paid) along stock under its repurchase
with the intangible assets of authorization and for the
$268 million. payment of dividends and
contributed $788 million to
• In the years 2003, 2004 and its pension and
2005, 3M business segments postretirement plans.

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3M paid its first dividend of 6 share) and $1.034 billion in 2004


cents per share in 1916 and since ($1.32 per share)2.
from then, it believes in
delivering sustainable and higher 3M invests large amount of
returns to the company’s expenditures in Research and
shareholder. Its dividend product development. Its total
expenditures totaled $1.268 expenditures regarding R&D
billion in 2005 ($1.68 per share), totaled $1.242 billion in 2005,
$1.125 billion in 2004 ($1.44 per $1.194 billion in 2004 and
$1.147 billion in 2003 including
2
Dividend per share over the
years have been shown in graph
given at appendix 2
the expenditures regarding the respect to short term and long
development of new and term senior debt securities.
improved products of $798
million in 2005, $759 million in
2004 and $749 million in 2003.
Regarding product development,
3M uses six sigma3 to increase
the productivity and operational
efficiencies by reducing defects
to deliver high performance,
reliable products to its
customers.

The company strongly believes


that its ongoing cash flows
provide great source of its
funding for expected
investments and capital
expenditures. It has sufficient
access to the capital markets to
meet its investment funding
needs. The company allocates its
funding needs from debt as well The table 1.1 (given in the
as from equity. It obtains appendix 1) comprises
finances from operations as well information about its short-term
as from long-term debt and and long-term debts along with
short-term borrowings i.e. by the interest rates and their
issuing and trading commercial maturity dates. Its overall long-
papers, medium term notes, term debt has increased from $
floating rate note, convertible 727 million to $1,309 million in
notes, and marketable securities. 2005 but its short-term debt has
decreased from $2,094 million
to $1,072 million in
2005.

3M has contingently
convertible 30-year
zero-coupon senior notes
which are redeemable
into 9.4602 shares of 3M
common stock after
some conditions have
been met. In 2005, the
conversion price for the
fourth quarter was $120
per share. In November
The company has entered into 2005, 22,506 out of the 639,000
various indentures with the outstanding bonds were
banks (including Citi Bank) with redeemed which resulted 3M to
payout approximately $20
3
Six sigma is explained in million.
detail in appendix 3
3M has various pension and post measuring plan liabilities for
retirement plans for its these plans and determines the
employees. 3M’s goal of this rate of return by analyzing the
investment strategy is to meet returns on fixed income
the obligations and earn the investment having similar
highest rate of return on duration liabilities (determined
actuarial basis. The company by
determines discount rate for

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recognized rating agencies). billion of


Table 1.2 (given in appendix 1) goodwill
depicts the discount rate, acquired from
expected rate of return estimated acquisitions
over the past few years. primarily
related to the
The company estimates its fair CUNO
value of assets and investments acquisition).
using discounted cash flow The impairment
analysis. It also uses discount testing of
rate to determine its fair value of goodwill is
obligation and liabilities. done at 3M Diamond Grade Reflective sheeting
Management makes estimation reporting level
and assumptions while showing to recognize
the long term effects of assets any impairment
and investments in the financial loss5 over the
statements and adjust those year.
assumptions according to the
changing circumstances and 3M has 18
requirements. reporting units
to which
3M uses net present value goodwill is
method to evaluate its directly assigned. The estimated
investment decisions. It uses 4 fair value of a reporting unit is
Mapping portfolio tools i.e. determined by discounted cash-
bubble diagram and ellipses to flow analysis or by multiplying
plot probability of success each reporting units’ earnings
against Net Present Value. with the price earning ratio for
comparable industry group.
3M invests heavily in intangible
assets including patents, The company also raises funds
goodwill, trademarks etc. In through repurchase of common
2005, 3M acquired goodwill of stock to support the stock based
$3.5 billion (including $1.002 5
Impairment loss is recognized
when carrying value of asset
4
Explanation is given in exceeds the fair value of the
Appendix 3. asset.
compensation plans and other
corporate purposes. The
company contributes treasury
shares, accounted at fair value to
employee savings plans to cover
obligations.

It has many stock option


ownership programs
including Employee stock
Ownership plan (ESOP),
General Employee stock
Ownership plan (GESPP)
and Management Stock
Ownership Program
6
(MSOP). Black-Scholes
option pricing model is used
for calculating the weighted
average fair value per option
at the date of grant for these
plans.

3M uses ‘Discount Dividend


Model7’ also known as
‘Gordon Model’ to evaluate
its dividend decisions. This
model calculates the present
value of the future dividends
that are expected to pay to
its shareholders in future. It
relates the market value of
the firm to its dividend
policy by calculating
expected return, current
dividend yield and projected
dividend growth.

6
Black-Scholes option pricing
model is discussed in detail in
appendix 3
7
Dividend Discount Model is
explained in detail in appendix
3
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CORPORATE STRATEGY principle),


employees are
allowed to spend
Innovation is the basic
15% of their
corporate strategy that 3M is
working time on
using for driving its
their own
organization. It invests a large
innovative ideas.
sum in its R&D and believes its
The company is
innovation and patents to be the
more than hundred
great sources of its competitive
years old and has
advantage. 3M's corporate
been through
strategy is based on a paradigm
various
shift towards 21st century
circumstances.
competitiveness that requires
Shift towards an
movement towards long term
innovative
“sustainable growth” without
organization has
compromise of financial
been gradual. It had to face
success. It has pursued this
many challenges and adapt to
goal, in part, through its
them by changing its
technical corporate culture with
organizational structure.
a workforce that is empowered
to innovate. In their annual
report for the year 2005 it is
stated:

“Every day, people at 3M find


ways to make life better and
easier for people around the
world. We increase and
efficiency by sharing
technologies, manufacturing
operations, brands and other
resources across our
businesses and geographies.
Our businesses produce
innovative products, hold
leading market positions and
generate solid returns on
investment.”

At 3M innovation is a dynamic
process. All employees are
encouraged to innovate and
according to the 15% rule (their
most famous management
the organization, to have a deep
CHALLENGES AND understanding of the changing
ORGANIZATIONAL needs of the environment and
CHANGES WITH enabled the individuals to be
creative and to be driven by
REFERENCE TO
their own will by
STRATEGIC communicating a clear vision
DEVELOPMENT of the future.
Some of the challenges faced
by the organization in the COMPETITORS
transformation into an
innovative organization are 3M is the member of
mentioned in the table 1.3 in conglomerate industry. No
Appendix 1. At 3M, Managers organization competes with 3M
are now engaging the staff for on all product platforms; it has
maximum innovation. This encountered strong competition
transformation required the in specific business lines. In
leaders to take responsibility particular, Avery Dennison
for articulating the direction, Corporation AVY), Johnson
for creating an environment and Johnson (JNJ) and DuPont
that empowers the members of (DD) compete with 3M.

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A comparison of 3M
performance with its
competitors is given in table FINANCIAL
1.4 in Appendix 1.
PERFORMANCE

3M’s corporate strategy has


great impact on its financial
performance. Due to the
increasing demand for its
innovative products and
effective decision making to
reach operational excellence
enabled the company to
generate the highest sales
revenue8 of $21.2 billion in
2005 with an increase of 5.4%

8
Graph representing the
sales revenue, EPS,
dividends per share over the
years have been given in
Appendix 2
over the previous year. It considered good as compared
reported a net income of $3.2 with the industry ratios and are
billion with an increase of sound according to the rule of
7.0%. thumb. The company currently
has a rating of AA credit rating
Operating income grew up to $5 from Standard & Poor’s and
billion with an increase of Aa1 credit rating from Moody’s
9.4%. Earnings per share Investors Service.
reported $4.12, 9.9% higher as
compared to the year 2004. In 2004, the current ratio for
Dividends per share with an 3M was 1.44 and it had
increase of 16.7% reported to decreased to 1.36 in 2005. For
$1.68. However because of 2004, the quick ratio was 1.12
heavy investments and payment and it decreased to 0.95 in
of some long term debts in 2005. However decline in debt
2005, the company reported a ratio from 20.4% in 2004 to
net decrease in cash & cash 14.0% and debt to equity ratio
equivalents of $1,685 million as from 0.27 to 0.24 in 2005 is a
compared to the year 2004. But positive sign.
these outflows were because of
heavy investments which would Overall increased profitability
benefit the company on the ratios, high amount of return on
long-term basis. investments, increase in sales,
and continuous payment of
While talking about the dividends to its stockholders
company’s ratios, there had over the years show the
been an improvement in its
profitability ratios as compared
to the previous years. Pretax
ROA increased from 23.78% in
2004 to 24.18% in 2005. ROE
increased by 5.4%. Return on
Common Equity (ROCE)
reported 31.04%. Gross Profit
Margin was 50.24% in 2004
and increased up to 50.96% in
2005, Operating Margin
(22.88% in 2004, 23.66% in
2005) and the Net Profit Margin
was increased from 14.94% in
2004 to 15.11% in 2005. company’s financial soundness
and increase the shareholder’s
The company’s liquidity ratios confidence to make the
declined because of decrease in company attractive for the
cash and cash equivalents in investors.
2005 but these ratios are still
3M Diamond Grade Reflective sheeting
Case study Page 10
11/23/2008

RISK MANAGEMENT

3M products and hence


“To understand uncertainty can affect the company’s
and risk is to understand the revenue and profit
key business problem – and margins.
the key business • As company makes almost
opportunity”— David B. 60% of its revenue from
Hertz, 1972. international markets
therefore its receivables,
Risk is the most important and expected returns for
factor incorporated in the the investments, sales and
capital budgeting decisions that earnings can be affected
directly influences the by exchange rate
credibility of an investment. fluctuations.
When a company invests in a • Developments of new
project, it always has some products may subject to
degree of uncertainty involved many risks and is largely
in it. Financial managers look dependent on the timings
for the projects whose expected of their launch and
rate of return is higher with less acceptance of that product
amount of risk involved in it to in the market. There is no
ensure shareholder’s wealth guarantee that all these
maximization and company’s products will be
profitability. commercially successful.

RISK FACTORS

3M deals with different types


of market and company risks.
Briefly, they are as follows:

• The effects of, and


changes in, worldwide
economic conditions e.g.
recession, social, political,
labor conditions or • Price fluctuations,
government policies in interruption in supply,
which company operates shortages of raw material,
etc. can have an impact on changing demand, natural
its results. disasters and other factors
• Change in consumer can have a material effect on
preferences, introduction the company’s results. e.g. In
and timings of competitive 2005, the company had to
products, changing face many problems
customer order patterns regarding costs and supply of
can affect the demand for oil-derived raw materials
because of hurricanes hit in and litigation including those
Katrina and Rita. involving product liability,
• Its capital budgeting property and other matters
decisions regarding can result in the outcomes
acquisitions, strategic other than those of estimated
alliances, divestitures and which can affect the future
other events resulting from results.
portfolio management
actions, possible RISK MANAGEMENT
organizational restructuring STRATEGY BEING
and any other change in its FOLLOWED BY 3M TO
business strategy can affect OFFSET RISKS
the future results. 3M has a financial risk
• The company’s future results management committee,
can be affected if company comprising senior management,
generates less productivity to deal with the company’s
improvements than financial risk policies and
estimated. provides guidelines and
• The Company and some of procedures for risk management
its subsidiaries are facing and derivative instrument
many claims, lawsuits, legal utilization for control and
and regulatory proceedings valuation.

Case study Page 11


11/23/2008

risk. It uses a mix of floating


and fixed
Regarding the risk factors interest rate
mentioned above, the company is debt and
using various techniques and uses interest
strategies to minimize these risks. rate swaps
The activities undertaken by the to help
management to offset these risks managing
are: the
• Hedging is the most borrowing
important activity which 3M costs. In
uses to counter risk. The 2005, half of
company has various the currency
contractual derivative impacts
arrangements to manage risks were
associated with foreign reduced by
exchange rate, interest rate hedging.
and commodity price risks. • The
The company uses interest company is engaged in
rate swaps, forward and supply contracts, price
option contracts to manage protection agreements and
forward physical contracts to (GAAP) and takes care of
ensure uninterrupted supply adopting new regulatory
throughout the year and to requirements that are
manage commodity price essential for the company to
risks. opt in order to come up to the
• The company is doing global international financial
sourcing for coping with the reporting standards. Its
commodity price inflation financial statements are
which would help in reducing audited by
the cost of raw material. PricewaterhouseCoopers LLP
• The company uses tools like which, (in the financial
six sigma to improve its statements of 2005 under the
operational efficiency and “Report of Independent
productivity to reduce its Registered Public Accounting
operational costs in order to Firm”), reports the 3M
avoid risk regarding new management to have an
product development. effective internal control over
the financial reporting.
• 3M uses variance/co-variance
statistical model named The company makes sure that
“third-party bank dataset9” to its financial reports are
assess interest rates, currency transparent and reflect the
fluctuations and the risks information about estimates,
associated with the loss in transactions, records,
after-tax earnings in financial policies, risks, assumptions
instruments and derivatives. and other publicly available
information, fairly and
properly.

3M’s COMPLIANCE WITH


LATEST REGULATORY
REQUIREMENTS

3M makes its financial


statements in accordance
with the Generally Accepted
Accounting Principles

9
Explanation is given in
Appendix 3
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3M is very much compliant to etc and certain part of the


new accounting and management financial statement including
policies and discloses all the management discussion on
material information in their performance of their future
financial statements and press expectations can be identified as
releases. e.g. In 2005, 3M forward-looking statements. The
adopted FASB Interpretation assumptions and estimations
No.47: “Accounting for made can differ from the actual
Conditional Asset Retirement results because of the risk factors
Obligations” (FIN 47) which discussed above.
requires to record fair value of
liability for a long term tangible The company’s provides
asset retirement obligation on maximum information about its
discounted basis. The adaptation policies and risk management but
of FIN47 resulted in an asset doesn’t imply any information
retirement obligation liability of about Capital Adequacy under
$59 million and after-tax charge value at Risk (VAR) and
of $35million which are aggregate risk because 3M
represented in 2005 income considers the disclosure of this
statement as cumulative effect of information to be a source of
accounting change. competitive advantage for its
competitors. The only
On January 1,2006, 3M adopted information available in the 3M
SFAS No. 123 (revised 2004), financial statement is that all the
“Share-Based Payment” to grant derivative activities governed at
stock-based compensation awards 3M are followed by written
to retirement eligible employees. policies and value-at-risk analysis
In September 2004, 3M adopted is performed for these
FASB’s Emerging Issues Task derivatives. They use Capital
Force finalized EIFT issue No. Adequacy under value at Risk
04-08, “The effect of but don’t want to disclose this
contingently convertible on information.
Diluted earnings per share”.
CONCLUSION
3M makes forward looking
statements to give a future view 3M is a multinational giant
about the company either as a with well-diversified portfolio
part of financial statements, in of products. Its significant
press releases or in other reports growth along with a steady
filed with the SEC. Forward flow of new and innovative
looking statements give products and the expense on
prediction about the company’s research, development and
future performance or plans. The related expenses are expected
words depicting future like to increase in the coming years
‘expect’, ‘will’, ‘plan’, ‘intend’ which require the company to
face new challenges regarding reports, the new
its capital budgeting decisions
that would directly impact the
regulatory
organization’s structure and requirements, does
company’s financial that mean that the
performance. In this rapidly company is clearly
changing global environment of
uncertainty, proper risk transparent?
management is necessary to Explain your
acquire required efficiency in answer.
order to have a good financial
management structure.
• How far the
company has been
DISCUSSION QUESTIONS able to pursue the
goal of having a
• What kind of balance between
corporate strategy shareholder’s
does 3M follow? wealth
And do you believe maximization and
that in the coming profit
years, that will maximization?
necessarily make
3M a market
leader?
• How will the
company’s capital
budgeting decisions
impact their
financial
performance in the
coming years?
• What further steps
should 3M take to
offset the risks that
they face? Do you
believe that the
strategies they are
currently following
are feasible or not?
• Just because the
company discloses
in their financial