INTRODUCTION

is considered as
one of the most
leading
multinational
companies in the world and is
ranked among the top ten
U.S. Companies in patents
granted. In the array of
thousands of products, 3M
products are considered to be
the most innovative. 3M
produces more than 200
innovative products each
year. With a ticker symbol of
MMM, It is listed on the New
York, Pacific, Chicago and
Swiss stock Exchange.
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
and office equipments. It is
said that a quarter of the
worlds population uses one
or more 3M products daily
and its demand for the
products is increasing day by
day leading the company to
make solid sales growth and
make further prosperity in
future.

With
referring
to
the
organizational growth and
success over the past few
years, the company continues
to invest in growth programs
and
brand
building
throughout the portfolio. Its
capital budgeting decisions
regarding
research
and
development
and
other
capital
expenditures
are
hoped to increase in every
coming year which requires
the challenges of meeting
growing needs for finances,
efficient
allocation
of
resources, making good
investment decisions and
most importantly maintaining
a balance between the
objective of profit and

shareholders
wealth
maximization. It has to have
a competitive edge and
maintain itself financially
sound
and
stable
in
accordance with the growing
global demand of its products
and increasing innovation in
the world.

WHY CAPITAL
BUDGETING DECISIONS
ARE IMPORTANT?

Capital Budgeting decisions

are the most important and
critical decisions that directly
influence the companys
performance in terms of
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
because they involve risk and
understanding of uncertainty
about each investment and
project, which is usually
difficult to analyze.

Case study

OVERVIEW / ANALYSIS

Since 3M makes almost 60% ofinvests

its
more than $1 billion per year
revenue from international markets
in research and development and
thats why its primary growth strategy
related activities, and is awarded
is based on continuing international
nearly 600 U.S. patents each year.
expansion and producing more
3Ms capital expenditures totaled
innovative products into new $943
or million in 2005 and are
existing markets.
Currently expected
3M
to increase up to $1.1 billion
manages its business operations ininsixthe year 2006. 1A brief overview
business segments i.e. Health care,
about
the
companys
capital
Industrial and Transportation, Display
budgeting activities over the past few
and Graphics, Consumer and Office,
years is given below:
Electro and communication, Safety
security and protection services.
In 2005, 3M spent about $26
million for capital projects related
3Ms FINANCIAL MANAGEMENT to protecting the environment
which are further expected to
STRUCTURE IN TERMS OF
CAPITAL BUDGETING DECISIONS increase to $35 million for new
programs to build pollution
control devices, modern facilities
modify
manufacturing
3Ms capital budgeting decisions areand
mostly related to its R&D,1
acquisitions,
strategic
alliances, Only few of the material
mergers, investments in plant,investments have been mentioned in
the analysis to give the readers idea
property, equipment and usually in
about the companys capital
available for sale securities.3Mbudgeting activities.

processes to minimize waste and

reduce emissions.

mostly has been paid) along

with the intangible assets of
$268 million.

In 2005, 3M announced to
build an LCD optical film
manufacturing facility in
Poland in order to cater to the
LCD-TV market in Europe
and to better serve its
customers.

In the years 2003, 2004 and

2005, 3M business segments
continued to buy 100% of
outstanding shares from
various
companies,
manufacturing lines and
subsidiaries for the purpose
of expansion and other
activities.
In 2006, company combined
its
industrial
and
transportation
business
segment to
increase
efficiency
and lower
down
its
operational
costs.

In 2005, 3M (industrial business

segment) acquired a CUNO
filtration
plant
for
purification of fluid and
gases for $1.36 billion ($1.27
billion paid in cash and $80
million of debt out of which

In

2005,

approximately $3.6 billion of

cash was used to repurchase
3M common stock under its
repurchase authorization and
for the payment of dividends
and contributed $788 million
to
its
pension
and
postretirement plans.

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3M paid its first dividend of 6

cents per share in 1916 and since
from then, it believes in
delivering sustainable and higher
returns to the companys

shareholder.
Its
dividend
expenditures totaled $1.268
billion in 2005 ($1.68 per share),
$1.125 billion in 2004 ($1.44 per

share) and $1.034 billion in 2004

($1.32 per share)2.
3M invests large amount of
expenditures in Research and
product development. Its total
expenditures regarding R&D
totaled $1.242 billion in 2005,
$1.194 billion in 2004 and
$1.147 billion in 2003 including
the expenditures regarding the
development of new and
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
2

Dividend per share over the

years have been shown in graph
given at appendix 2
3
Six sigma is explained in
detail in appendix 3

needs. The company allocates its

funding needs from debt as well
as from equity. It obtains
finances from operations as well
as from long-term debt and
short-term borrowings i.e. by
issuing and trading commercial
papers, medium term notes,
floating rate note, convertible
notes, and marketable securities.
The company has entered into
various indentures with the
banks (including Citi Bank) with
respect to short term and long
term senior debt securities.

The table 1.1 (given in

the
appendix
1)
comprises information about its
short-term and long-term debts
along with the interest rates and
their maturity dates. Its overall
long-term debt has increased
from $ 727 million to $1,309
million in 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 2005, 22,506 out of
the 639,000 outstanding bonds
were redeemed which resulted
3M to payout approximately $20
million.
3M has various pension and post
retirement
plans
for
its

employees. 3Ms goal of this

investment strategy is to meet
the obligations and earn the
highest rate of return on actuarial
basis. The company determines
discount rate for measuring plan
liabilities for these plans and
determines the rate of return by
analyzing the returns on fixed
income
investment
having
similar
duration
liabilities
(determined by

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recognized rating agencies).

Table 1.2 (given in appendix 1)
depicts the discount rate,
expected rate of return estimated
over the past few years.
The company estimates its fair
value of assets and investments
using discounted cash flow
analysis. It also uses discount
rate to determine its fair value of
obligation
and
liabilities.
Management makes estimation
and assumptions while showing
the long term effects of assets
and investments in the financial
statements and adjust those
assumptions according to the
changing circumstances and
requirements.
3M uses net present value
method
to
evaluate
its
investment decisions. It uses
4
Mapping portfolio tools i.e.
bubble diagram and ellipses to
plot probability of success
against Net Present Value.
4

Explanation is given in
Appendix 3.

3M
invests
heavily
in
intangible
assets including
patents,
goodwill,
trademarks etc.
In 2005, 3M
acquired
goodwill
of
3M Diamond Grade Reflective sheeting
$3.5
billion
(including
$1.002 billion
of
goodwill
acquired from
acquisitions
primarily
related to the
CUNO
acquisition).
The impairment
testing of goodwill is done at
reporting level to recognize any
impairment loss5 over the year.
5

Impairment loss is recognized

when carrying value of asset
exceeds the fair value of the
asset.

3M has 18 reporting units to

which goodwill is directly
assigned. The estimated fair
value of a reporting unit is
determined by discounted cashflow analysis or by multiplying
each reporting units earnings
with the price earning ratio for
comparable industry group.
The company also raises funds
through repurchase of common
stock to support the stock based
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
6

Black-Scholes option pricing

model is discussed in detail in
appendix 3
7
Dividend Discount Model is
explained in detail in appendix
3

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.

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CORPORATE STRATEGY

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

CHALLENGES AND
ORGANIZATIONAL
CHANGES WITH
REFERENCE TO
STRATEGIC
DEVELOPMENT
Some of the challenges faced
by the organization in the
transformation
into
an
innovative organization are
mentioned in the table 1.3 in
Appendix 1. At 3M, Managers
are now engaging the staff for
maximum innovation. This
transformation required the
leaders to take responsibility

for articulating the direction,

for creating an environment
that empowers the members of
the organization, to have a deep
understanding of the changing
needs of the environment and
enabled the individuals to be
creative and to be driven by
their
own
will
by
communicating a clear vision
of the future.

COMPETITORS
3M is the member of
conglomerate industry. No
organization competes with 3M
on all product platforms; it has
encountered strong competition
in specific business lines. In
particular, Avery Dennison
Corporation AVY), Johnson
and Johnson (JNJ) and DuPont
(DD) compete with 3M.

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

FINANCIAL
PERFORMANCE

3Ms 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%
over the previous year. It
reported a net income of $3.2
billion with an increase of
7.0%.
Operating income grew up to $5
billion with an increase of
9.4%.
Earnings per share
reported $4.12, 9.9% higher as
compared to the year 2004.
Dividends per share with an
increase of 16.7% reported to
$1.68. However because of
heavy investments and payment
of some long term debts in
2005, the company reported a
net decrease in cash & cash
equivalents of $1,685 million as
compared to the year 2004. But
these outflows were because of
heavy investments which would
benefit the company on the
long-term basis.
While talking about the
companys ratios, there had
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
8

Graph representing the

sales revenue, EPS,
dividends per share over the
years have been given in
Appendix 2

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.
The companys liquidity ratios
declined because of decrease in
cash and cash equivalents in
2005 but these ratios are still
considered good as compared
with the industry ratios and are
sound according to the rule of
thumb. The company currently
has a rating of AA credit rating
from Standard & Poors and
Aa1 credit rating from Moodys
Investors Service.
In 2004, the current ratio for
3M was 1.44 and it had
decreased to 1.36 in 2005. For
2004, the quick ratio was 1.12
and it decreased to 0.95 in
2005. However decline in debt
ratio from 20.4% in 2004 to
14.0% and debt to equity ratio
from 0.27 to 0.24 in 2005 is a
positive sign.
Overall increased profitability
ratios, high amount of return on
investments, increase in sales,
and continuous payment of
dividends to its stockholders
over the years show the
companys financial soundness
and increase the shareholders
confidence to make the
company attractive for the
investors.
3M Diamond Grade Reflective sheeting

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RISK MANAGEMENT

To understand uncertainty
and risk is to understand the
key business problem and the
key business opportunity
David B. Hertz, 1972.
Risk is the most important
factor incorporated in the
capital budgeting decisions that
directly
influences
the
credibility of an investment.
When a company invests in a
project, it always has some
degree of uncertainty involved
in it. Financial managers look
for the projects whose expected
rate of return is higher with less
amount of risk involved in it to
ensure shareholders wealth
maximization and companys
profitability.

RISK FACTORS

Change
in
consumer
preferences, introduction and
timings
of
competitive
products, changing customer
order patterns can affect the
demand for 3M products and
hence can affect the companys
revenue and profit margins.
As company makes almost
60% of its revenue from
international markets therefore
its receivables, and expected
returns for the investments,
sales and earnings can be
affected by exchange rate
fluctuations.
Developments
of
new
products may subject to many
risks and is largely dependent
on the timings of their launch
and acceptance of that product
in the market. There is no
guarantee that all these
products will be commercially
successful.

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
government
policies in which company
operates etc. can have an
impact on its results.

Price fluctuations, interruption

in supply, shortages of raw
material,
changing
demand,
natural disasters and other factors

can have a material effect on the

companys results. e.g. In 2005,
the company had to face many
problems regarding costs and
supply of oil-derived raw
materials because of hurricanes
hit in Katrina and Rita.
Its capital budgeting decisions
regarding acquisitions, strategic
alliances, divestitures and other
events resulting from portfolio
management actions, possible
organizational restructuring and
any other change in its business
strategy can affect the future
results.
The companys future results
can be affected if company
generates
less
productivity
improvements than estimated.
The Company and some of its
subsidiaries are facing many
claims, lawsuits, legal and
regulatory
proceedings
and

Case study

litigation
including
those
involving
product
liability,
property and other matters can
result in the outcomes other than
those of estimated which can
affect the future results.

RISK MANAGEMENT
STRATEGY BEING
FOLLOWED BY 3M TO
OFFSET RISKS
3M has a financial risk
management
committee,
comprising senior management,
to deal with the companys
financial risk policies and
provides
guidelines
and
procedures for risk management
and
derivative
instrument
utilization for control and
valuation.

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Regarding the risk factors

mentioned above, the company is
using various techniques and
strategies to minimize these risks.
The activities undertaken by the
management to offset these risks
are:

Hedging is the most

important activity which 3M uses
to counter risk. The company has
various contractual derivative
arrangements to manage risks
associated with foreign exchange
rate, interest rate and commodity
price risks. The company uses
interest rate swaps, forward and

option contracts to manage risk.

It uses a mix of
floating
and
fixed
interest
rate debt and
uses interest rate
swaps to help
managing
the
borrowing costs.
In 2005, half of
the
currency
impacts
were
reduced
by
hedging.

The
company
is
engaged
in
supply contracts,

price protection agreements and

forward physical contracts to
ensure uninterrupted supply
throughout the year and to
manage commodity price risks.

The company is doing

global sourcing for coping with
the commodity price inflation
which would help in reducing the
cost of raw material.

The company uses tools

like six sigma to improve its
operational
efficiency
and
productivity to reduce its
operational costs in order to
avoid risk regarding new product
development.

3M uses variance/covariance statistical model named

third-party bank dataset 9 to
assess interest rates, currency
fluctuations and the risks
associated with the loss in aftertax
earnings
in
financial
instruments and derivatives.

3Ms COMPLIANCE WITH

LATEST REGULATORY
REQUIREMENTS

3M makes its financial

statements in accordance
9

Explanation is given in
Appendix 3

with the Generally Accepted

Accounting
Principles
(GAAP) and takes care of
adopting new regulatory
requirements
that
are
essential for the company to
opt in order to come up to the
international
financial
reporting
standards.
Its
financial
statements
are
audited
by
PricewaterhouseCoopers LLP
which, (in the financial
statements of 2005 under the
Report
of
Independent
Registered Public Accounting
Firm), reports the 3M
management to have an
effective internal control over
the financial reporting.
The company makes sure that
its financial reports are
transparent and reflect the
information about estimates,
transactions,
records,
policies,
risks,
assumptions and other
publicly
available
information, fairly and
properly.

Case study
13

Page

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3M is very much compliant to

new accounting and management
policies and discloses all the
material information in their
financial statements and press
releases. e.g. In 2005, 3M
adopted FASB Interpretation
No.47:
Accounting
for
Conditional Asset Retirement
Obligations (FIN 47) which
requires to record fair value of
liability for a long term tangible
asset retirement obligation on
discounted basis. The adaptation
of FIN47 resulted in an asset
retirement obligation liability of
$59 million and after-tax charge
of
$35million
which
are
represented in 2005 income
statement as cumulative effect of
accounting change.
On January 1,2006, 3M adopted
SFAS No. 123 (revised 2004),
Share-Based Payment to grant
stock-based compensation awards
to retirement eligible employees.
In September 2004, 3M adopted
FASBs Emerging Issues Task
Force finalized EIFT issue No.
04-08,
The
effect
of
contingently
convertible
on
Diluted earnings per share.
3M makes forward looking
statements to give a future view
about the company either as a
part of financial statements, in
press releases or in other reports
filed with the SEC. Forward
looking
statements
give
prediction about the companys
future performance or plans. The

words depicting future like

expect, will, plan, intend
etc and certain part of the
financial statement including
management
discussion
on
performance of their future
expectations can be identified as
forward-looking statements. The
assumptions and estimations
made can differ from the actual
results because of the risk factors
discussed above.
The
companys
provides
maximum information about its
policies and risk management but
doesnt imply any information
about Capital Adequacy under
value at Risk (VAR) and
aggregate risk because 3M
considers the disclosure of this
information to be a source of
competitive advantage for its
competitors.
The
only
information available in the 3M
financial statement is that all the
derivative activities governed at
3M are followed by written
policies and value-at-risk analysis
is performed for these
derivatives. They use Capital
Adequacy under value at Risk
but dont want to disclose this
information.

CONCLUSION

3M is a multinational giant
with well-diversified portfolio
of products. Its significant
growth along with a steady

flow of new and innovative

products and the expense on
research, development and
related expenses are expected
to increase in the coming years
which require the company to
face new challenges regarding
its capital budgeting decisions
that would directly impact the
organizations structure and
companys
financial
performance. In this rapidly
changing global environment of
uncertainty,
proper
risk
management is necessary to
acquire required efficiency in
order to have a good financial
management structure.

DISCUSSION QUESTIONS

What kind of corporate

strategy does 3M follow?
And do you believe that in
the coming years, that will
necessarily make 3M a
market leader?
How will the companys
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
reports, the new regulatory
requirements, does that
mean that the company is
clearly
transparent?
Explain your answer.

How far the company has

been able to pursue the
goal of having a balance
between
shareholders
wealth maximization and
profit maximization?

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