3m equity valuation - texas tech...

3M Equity Valuation

By:

Chris Carr – [email protected]

Matt Tharp – [email protected]

Anthony LeMaire – [email protected]

Bryan Coats – [email protected]

Ryan Sirles – [email protected]

Table of Contents

Executive Summary ............................................................................................................ 3 Business & Industry Analysis:............................................................................................ 3

Company Overview ........................................................................................................ 3 Five Forces Model .......................................................................................................... 4 Key Success Factors ....................................................................................................... 8 Competitive Strategy Analysis ....................................................................................... 9

Accounting Analysis:........................................................................................................ 11 Key Accounting Policies............................................................................................... 11 Accounting Flexibility .................................................................................................. 14 Evaluating Accounting Strategy ................................................................................... 16 Screening Ratio Analysis.............................................................................................. 18 Potential Red Flags ....................................................................................................... 23 Undoing Accounting Distortions .................................................................................. 24

Ratio Analysis and Forecast Financials ............................................................................ 25 Financial Ratio Analysis ............................................................................................... 25 Cross Sectional Analysis............................................................................................... 29 Financial Statement Forecasting Methodology ............................................................ 44

Valuation Analysis............................................................................................................ 47 Methods of Comparables .............................................................................................. 47 WACC........................................................................................................................... 50 Discounted Dividends................................................................................................... 53 Free Cash Flows............................................................................................................ 55 Residual Income............................................................................................................ 56 Long-Run Average Residual Income Perpetuity .......................................................... 58 Abnormal Earnings Growth.......................................................................................... 59 Altman Z-score ............................................................................................................. 60 Summary of Valuations ................................................................................................ 61

Appendix........................................................................................................................... 62

- 2 -

Executive Summary

Company Valued: 3M Investment Recommendation: Slightly Over Valued Date of Valuation: November 1, 2006

EPS Forecasts FYE 11/1 2006(A) 2007(E) 2008(E) 2009(E) EPS 4.71 5.26 5.87 6.54 Valuation Ratio Comparison 3M Industry Avg Trailing P/E 17.14 21.88 Forward P/E 20.37 16.65 Forward PEG 1.53 1.63 M/B 2.3 2.45 Valuation Estimates Actual Current Price $79.98 Ratio Based Valuations P/E Trailing $100.63 P/E Forward $76.57 PEG Forward $48.62 Dividend Yield $2.30 M/B Intrinsic Valuations Discounted Dividends $31.53 Free Cash Flows $49.04 Residual Income $89.60 Abnormal Earnings Growth $108.93 Long Run Res. Income Perp $47.36

MMM- NYSE (12/01/06) $79.98 52 Week Price Range $67.05-$88.35 Revenue (2005) $21,167,000 Market Capitalization $58,890,000,000 Shares Outstanding 775 million Div. Yield 2.30% 3-month Avg. Daily trade volume 2,816,850 Percent Institutional Ownership 66.60% Book Value per Share (mrq) 14.915 ROE (most recent year) 33.39% ROA (most recent year) 15.019% Cost of Capital Estimates Beta R^2 Ke 10-year Beta .625 14.4% 9.06% 5-year Beta .626 14.5% 9.07% 1-year Beta .613 13.7% 9.30% 3-month Beta -1.39 14.2% 2.92% Published Beta .83 Kd 4.66% WACC (bt) 9.10% Atlman Z-Score 3.12

- 3 -

http://images.google.com/imgres?imgurl=http://www.safetyforces.com/images/3M-logo-large.gif&imgrefurl=http://www.angelfire.com/fl5/verhoef/te_werk.htm&h=157&w=235&sz=4&hl=en&start=4&tbnid=OjhqGMl-8nJoLM:&tbnh=73&tbnw=109&prev=/images%3Fq%3D3M%2Blogo%26svnum%3D10%26hl%3Den%26lr%3D%26sa%3DN

- 4 -

3M is a diversified technological company that has operations in six separate

industry segments. These six segments include: the health care industry,

industrial and transportation business, consumer and office business, display and

graphics, electro and communication business and safety security and protection

services. Relative to each business segment, there is a moderate level of rivalry

among existing firms and threat of substitutes and a low threat of new entrants

and bargaining power of buyers and suppliers. 3M has established a position in

the market based on extensive research and development, investment in brand

image, and producing quality and a variety of products. Furthermore, these

success factors have helped 3M remain active with main competitors Johnson

and Johnson and Avery Dennison. Though there are more competitors other

than these two, none of them are publicly traded. Therefore, we did not have

access to their financial statements in order to properly evaluate and compare

them to 3M.

3M has implemented key accounting policies that best suit the success factors of

the company. There are multiple flexible accounting policies that the company

implements including inventory control, lease obligations, and post-employment

pension plans. Also, 3M practices aggressive accounting strategies by reporting

higher earnings per share than the competition. By performing a ratio analysis

for the previous five years, we found that there were no manipulations in their

accounting practices or financial statements. This proves that 3M discloses all

significant accounting information and is transparent.

Performing financial ratio analysis allowed us to examine the effectiveness of 3M,

which is important to investors and stockholders. 3M showed to have a positive

liquidity analysis with all ratios, except the current ratio, showing positive

outlooks. Operating efficiency ratios, which include the gross profit margin,

operating expense ratio, and net profit margin, also showed positive results.

Other ratios of profitability indicated mixed results. For example, asset turnover

showed a negative impact while return on assets showed a favorable impact.

The capital structure ratios prove that 3M finances its operations efficiently.

- 5 -

Developing a cross sectional analysis of 3M’s top competitors allowed for a

comparison of 3M within the industry.

Forecasting the financial statements allowed us to foresee 3M’s structure for the

next ten years. Due to the diversification of the company, we believe they will

be able to maintain a slow and steady growth. These forecasts were computed

and analyzed with great caution because these numbers are keys to finding the

value of the firm.

Using the forecasted numbers, along with the observed current stock price, we

developed different valuation models to measure the value of the firm. These

models include weighted average cost of capital, method of comparables,

discounted dividends, free cash flows, residual income, long run return on equity

perpetuity, and abnormal earnings growth. Discounted dividends, free cash

flows, and long run return on equity perpetuity stated that 3M is overvalued,

while residual income and abnormal earnings growth stated they are

undervalued. Therefore, by computing an average of the intrinsic valuations, we

found that 3M is slightly overvalued.

- 3 -

Business & Industry Analysis:

Company Overview

3M Company, formally known as Minnesota Mining and Manufacturing Company,

is a diversified technology company that prides itself on innovation. Founded in

1902 to mine a small mineral deposit and has since developed into a global

company with operations in over 60 countries, including headquarters based in

St. Paul Minnesota. Over the last 104 years, 3M has grown and strengthened its

operations into six diversified industry segments: the health care industry,

industrial and transportation business, consumer and office business, display and

graphics, electro and communication business and safety security & protection

services. 3M was incorporated in 1929 and the market capitalization has grown

to 55.07 billion dollars. Main competitors for 3M are Avery and Bayer, which are

among the industries leaders in the consumer and office industry and the health

care industry. 3M will continue to innovate and apply technologies to an endless

array of customer needs.

Sales Volume and Total Asset Value Table in Millions 2001 2002 2003 2004 2005 World Wide Sales 16,054 16,332 18,232 20,011 21,167 Total Asset Value 14,606 15,329 17,600 20,708 20,513

Average Stock Price over past 5 years:

0102030405060708090

2001 2002 2003 2004 2005 2006

Stock Price

Conglomerate Industry Rivalry Among Existing Firms Moderate

Threat of New Entrants Low

Threat of Substitutes Moderate

Bargaining Power of Buyers Low

Bargaining Power of Suppliers Low

Five Forces Model

Porters “Five Forces Model” is a widely used competitive analysis to develop

industry strategies. Porter has broken down the nature of competitiveness into

five forces: Rivalry among Existing Firms, Threat of New Entrants, Threat of

Substitutes, Bargaining Power of Buyers, and Bargaining Power of Suppliers. In

our analysis we will be analyzing the industry of conglomerates; in particular the

sectors of Healthcare, and Office Supplies.

Competitive Force 1: Rivalry among Existing Firms

Rivalry among existing firms is usually the most significant competitive force in

an industry. The competitiveness of one firm over another solely relies on the

- 4 -

- 5 -

ability of a firm’s strategies to yield a competitive advantage over the

competition, which can not be duplicated quickly.

In the conglomerate industries of Healthcare and Office Supplies, there is a

moderate level of rivalry among existing firms. This is due in large part to the

small size of the industry and the large size of each firm. Competition for a

conglomerate not only comes from other competing conglomerates but niche

firms as well. However, because of a conglomerates size, niche firms don’t pose

much of a direct threat. The reason for this is because a conglomerate has a

much greater purchasing power and more R&D Departments which allow them

to compete on prices, whereas niche companies have to compete on

differentiation.

Thus there are two ways for there to be true competition, an existing

conglomerate moves into another conglomerate’s division or a niche firm creates

a strong competitive advantage where the conglomerate can’t or does not want

to compete. This is why these two industries are rated at a moderate level for

the Threat of Existing Firms.

Conglomerates in general dominate others by scale. Their size keeps the smaller

competitors behind or at bay. This is because conglomerates can pool resources

from all divisions and feed it into research and development. This means

conglomerates are usually the ones to establish the “learning curve.”

Establishing the learning curve also establishes the “First Mover” advantage. First

mover advantage is established when a company is the first in the industry to be

doing something in a particular way or producing a particular good. Thus being

the first to reap the benefits. A conglomerates size also increases their buying

power which reduces the costs passed on to the consumers.

- 6 -

Competitive Force 2: Threat of New Entrants

The industries of Healthcare and Office Supplies exhibit high barriers to entry, so

the threat of new entrants is low. The high barriers are created by the amount of

capital (money) and time it takes to become a competitor in these sectors. For a

firm to become a new entrant in the market, they would have to buy-up a pre-

existing firm or start their own from the ground up. Either way it would take an

extreme amount of capital to do so. The element of time also plays a major role.

It takes a considerable amount of time to set up a particular firm (including

R&D), along with all the time spent networking. It is vital in any industry to be

properly networked with suppliers, and distributors. A new entrant would face

the problem of finding a supplier that would sell its goods at low enough prices

to compete with pre-existing firms. This is because in this day and age the

supplier/purchaser relationship is quite close. It is common now for there to be

contracts set up between a supplier and purchaser that stipulate terms such as

locked prices, and exclusivity between the supplier and purchaser.

Competitive Force 3: Threat of Substitutes

Almost all industries deal with the threat of substitute products. The major

concern with substitutable products is how similar the product is, what additional

benefits it might yield, and the products comparable price.

Threat of Substitutes is at a moderate level in the Healthcare, and Office &

Supply industries. This level is due to the broadness of each of the two

industries. Both industries encompass a vast array of goods, so there are many

opportunities for substitutes. The healthcare sector ranges from:

pharmaceuticals to stethoscopes and the office and supply sector ranges from:

post-its to computer filters. This is why both these industries have huge R&D

departments. They want to be a “First Mover” by establishing a new product or a

new way of producing a pre-existing product. If you can be the first to come up

with a product you will reap the initial benefits of the product’s entrance and will

also establish the original patent on the good. Others will then be forced to

- 7 -

differentiate their products if they wish to compete in the market. This action will

take more time and money then the first mover.

Competitive Force 4: Bargaining Power of Buyers

This is the strength or power the customers have over a firm which includes

controlling what the company produces and the price at which the product sells.

“Monopsonistic buyers use their power to extract better terms at the expense of

the market. In a truly competitive market, no one buyer can set the prices.

Instead they are set by supply and demand.” (Photopla) In the Healthcare, and

Office & Supply sectors the bargaining power of the buyers is low. These two

sectors are more supply and demand sensitive because there are a limited

number of suppliers and the demand for the products is quite high. The two

components that make up the bargaining power of the buyers are the price

sensitivity and the relative bargaining power. Price sensitivity is eliminated by the

fact there are numerous buyers and limited sellers. There is also low relative

bargaining power because no one buyer purchases a controlling amount of the

product to give them the power to stipulate additional terms.

Competitive Force 5: Bargaining Power of Suppliers

Similar to that of Bargaining Power of Buyers, the more suppliers there are the

less power they hold over the firms. The alternative though, is when there are

few suppliers. These few suppliers can have quite a bit of control over the firms

that purchase goods and resources from them. It all goes back to the Theory of

Supply & Demand; the greater the demand or the smaller the supply the greater

the price of the good or services. The Healthcare and Office & Supply sector’s

“Bargaining Power of Suppliers” is low. This is due in most part because of their

size. They have the ability to purchase large quantities of materials from their

suppliers and are one of the top customers. Thus, it would be irrational for the

supplier to tell them, “This is the price you will pay and like it.” In retrospect it

would be the other way around. The buyer has the ability to tell the supplier

“This is how much we want, we want it on this date, and we are willing to pay

this for it.”

- 8 -

Also the firms in these two industries use relatively general materials/ resources

because they are developing initial goods to go into other firm’s goods. Because

of the geniality of the resources, there are numerous suppliers and the firms can

leverage them against one another to get the best price. This mean if their

supplier does not give them the deal they want, they can go else where. As with

all industries, when you are the only one or one of a few providing a good that is

in demand, you can charge a premium for the good. However, if you are in an

industry with a lot of competition between firms for customers, the customer will

be empowered by the situation.

Key Success Factors

3M’s success is captured from the company’s ability to diversify its operations

across six industry segments. A majority of 3M’s success is accredited to the

company’s investment in research and development. 3M’s research and

development is the company’s leading core success factor, which stimulates 3M’s

long-term growth and stability. Another success factor 3M incorporates into its

business strategy is investment in growth programs and brand image. These

investments make up a large proportion of the companies selling and

administrative expenses which can be found on the 3M’s income statements. For

the past three years, 3M’s SG&A expense has been around 21% of net sells. 3M

believes that investing great amounts of capital into brand imaging will help

continue to separate their products from the industry mix in the market place.

3M’s success also relies on the company’s ability to create a superior quality

product and a superior product variety. 3M capitalizes on this approach by

already being diversified across six different business segments and for already

striving to create a brand image that reflects quality.

- 9 -

Competitive Strategy Analysis

The main competitive advantage 3M possesses is how it manages to stay ahead

of the competition by investing vast amounts of capital and resources into

research and development in order to maintain a strong presence in the industry.

They try to utilize their resources to both create new products and improve on

existing products as well. Their R & D expenses have steadily increased over

recent years. In 2005, 3M invested 798 million dollars into the research and

development of new products and ideas (3m.com), which is approximately 50

million greater than in 2003. Also, 3M combines the disclosure of R & D with

other related expenses, primarily including technical customer support and the

preparing, filing, securing, and maintaining of internal patents. These other

related expenses totaled 444 million in 2005. Because 3M invests great amounts

of capital into R & D and the other related expenses, they are able to produce

products with superior quality. Furthermore, the acquisition of other companies

compliments 3M’s research and development strategy. This allows 3M to use

other company’s ideas and developed products instead of strictly focusing on

developing their own new products. For example, in August of 2005 3M acquired

CUNO, a liquid filtration company, for $1.36 billion. This acquisition allowed for

the combination of both companies’ output and technology along with the

research and development departments to provide for a wider range of

customers.

Investment in brand image has helped create another competitive advantage for

3M. Customers associate 3M’s brand with quality and exceptional performance.

3M may not always have the lowest price, but their products are made to outlast

the competition.

Another competitive advantage is that 3M is a diversified company that strives to

be the leader in product innovation among its competitors. 3M focuses on a

differentiation strategy in order to produce a variety of quality products to its

consumers. However, since 3M is a conglomerate, they are diversified over six

major industries in the market, which forces them to also focus on a cost

leadership strategy as well. The traditional view of strategy researchers is that

cost leadership and product differentiation are mutually exclusive. This, however,

is not the case for 3M. Because 3M is a diversified company, the same business

strategy cannot be implemented for every product and service provided.

Furthermore, the diversification of product variety allows 3M to focus on certain

factors that will help them compete with other products within their industries.

Even though the majority of 3Ms products focus on differentiation, some are

basic commodity products with substitutes, such as the Post-It notes and Scotch

Tape, and must compete on a cost leadership strategy.

- 10 -

Accounting Analysis:

In this section, we will be discussing different accounting methods to measure

the credibility of 3M’s financial statements. These methods include key

accounting policies, accounting flexibility, evaluating accounting strategy, quality

of disclosure, identifying potential red flags, and undoing any accounting

distortions.

Key Accounting Policies

3M is a diversified technology company with business in health care; industrial

and transportation; display and graphics; consumer and office; safety, security

and protection services; electronics and telecommunication. They have

implemented key accounting policies that best fits the success factors of a

diversified manufacturing company. Many of these key success factors include

research and development, brand image, and product variety and quality. The

most significant policies are outlined below:

Consolidation

3M is a conglomerate of many different businesses in a multitude of markets.

Because of the wide variety of products and industries, all significant subsidiaries

are consolidated and inter company transactions are eliminated. For example,

research and development expenses are recorded as overall company expenses

rather than individual expenses for each segment.

- 11 -

Foreign Currency Translation

Exchange rates are important because 3M maintains operations in 60 different

countries and produces different products in nearly 200 countries. Because of

the vast amount of foreign produced products, this links to the success factor of

product variety. Assets and liabilities for operations outside the United States

are translated at year-end exchange rates. Income and expense items are

translated at average rates of exchange. Cumulative translation adjustments are

recorded as accumulated other comprehensive income or loss in stockholders’

equity.

Cash, Cash equivalents, and Inventories

Inventories are valued at lower of cost or market. Costs are generally

determined with Fist-in, First-out (FIFO) basis. Cash and cash equivalents

consist of cash and temporary investments with maturities of three months or

less when purchased. 3M maintains about 5% of their total assets in cash and

cash equivalents. This helps 3M maintain a constant current ratio which

establishes high creditability for the firm in the eyes of their investors.

Long Term Assets

Property Plant and Equipment is mainly utilized for creating quality products as

well as research and development of new products. 3M’s technologically

advanced equipment and facilities produce the superior quality and variety seen

in their products today. Depreciation of Property Plant and Equipment is

generally computed using the straight-line method based on the estimated useful

lives of the asset. Goodwill is tested for impairment annually, and will be tested

for impairment between annual tests if an event occurs or circumstances change

that would indicate the carrying amount may be impaired.

- 12 -

Revenues

Generating revenues helps promote the brand image of 3M because portions of

these earnings are used to advertise 3M’s products, bringing greater exposure to

the company’s name. Also, higher revenues help provide better services for

customers. The majority of 3M’s sales agreements are for standard products and

services with customer acceptance occurring upon delivery of the product or

performance of the service. For prepaid service contracts, sales revenue is

recognized on a straight-line basis over the term of the contract, unless historical

evidence indicates the costs are incurred differently. License fee revenue is

recognized as earned, with no revenue recognized until the inception of the

license term. Sometimes agreements will contain milestones, or 3M will

recognize revenues based on proportional performance.

Accounts Receivable and Allowances

3M maintains allowances for bad debts, cash discounts, product returns and

various other adjustments that lower income. These accounts are based on the

best estimates of many different items including historical write-off experience by

industry, regional economic data, and historical sales returns.

Research, Development and related expenses

Research and development is a key success factor and a very important part of

3M’s success. Products resulting form research and development have been a

major factor in 3M’s growth. These costs that are incurred throughout the year

are charged to operations.

Critical Accounting Estimates

Many of the critical accounting estimates that 3M’s managers make are based off

of historical estimates and other assumptions. 3M is required to make estimates

and assumptions that affect the reported amounts of assets, liabilities, revenue

- 13 -

and expenses, and related disclosure of contingent assets and liabilities. Though

the company thinks the most critical accounting estimates are legal proceedings,

3M’s pension and postretirement obligations, and potential asset impairment

issues. In the notes 3M makes a claim that actual results could differ from

estimates.

Accounting Flexibility

Being that 3m is in the business of diverse technologies and manufacturing, the

FASB allows certain flexibility in their accounting methods while still being in

compliance with the policies set forth to them by the United States and the

Securities and Exchange Commission. Many of 3M’s key accounting policies are

reported with flexibility. In the recent 10-K filings 3M noted flexibility in

depreciation, amortization, pension and post-employment benefits, and

inventories control. Due to 3M’s flexible accounting procedures various footnotes

are embedded throughout their financial statements explaining key accounting

policies.

3M employs straight line depreciation based on the estimated useful lives of their

long-term assets. Fully depreciated assets are retained in accumulated

depreciation and property accounts until the disposal of the asset. Upon

disposal, assets and related accumulated depreciation are removed from the

accounts and the net amount, less proceeds from disposal, is charged or credited

to operations. This is the main procedure that is routinely updated for the

accounting of long-term assets. The estimated useful lives of buildings and

improvements primarily range between 10 to 40 years, while machinery is

estimated between three to 15 years. The amount of years 3M uses for

calculating its estimated useful life is a major component used when also

accounting for long term assets. Capital and operating leases show a significant

- 14 -

increase in the last three years due largely in part to expansion of leases

throughout the world. By owning these leases, 3M is provided with the locations

to spread their product quality and variety throughout the world. It is 3M’s

practice to secure renewal rights for leases, thereby giving 3M the right, but not

the obligation, to maintain presence in a leased facility. 3M’s accounting of

foreign currency translation is used primarily when accounting for sales and

prices in other countries, but is also used when computing lease agreements on

facilities located in foreign countries. This is very important considering 3M has

operations in 60 countries.

The flexibility is also shown by the treatment and reporting of goodwill. 3M

does not amortize their goodwill, but they do routinely test it for impairment on a

periodic basis or if an event occurs or circumstances change that would indicate

the carrying amount may be impaired. This is an example of the critical

accounting estimates used by 3M’s accounting department. In the fourth quarter

of 2005, 3M reported no impairment of goodwill. In regards to inventory control,

3M states their inventories at lower of cost or market and employs the FIFO

method, in which net income is understated. The understatement of inventory

thus alters the reported true value on their financial statements.

Post employment benefit plans include employee stock options which are

expensed according to SFAS 123R requiring compensation expense when an

employee is eligible to retire. 3M employees are eligible to retire at age 55 and

having completed five years of service. Pension and post retirement benefits for

healthcare costs are managed on a going-concern basis. The primary goal is to

meet current obligations, and the secondary goal is to earn the highest rate of

return possible without putting its primary goal in jeopardy. Expected return on

plan assets for 2005 was 8.5 percent. 3M’s post retirement benefit plans provide

the public along with current and previous workers a positive image of the

company. This helps increase brand image which is a key success factor.

- 15 -

Research and development costs are charged to operations in the year incurred

and are not amortized. These costs include scientific research and the application

of the scientific advances to the production of new and improved products.

Research and Development (millions)

2001 2002 2003 2004 2005

745 738 749 759 798

Evaluating Accounting Strategy

The accounting strategies of 3M and the industry competitors show that 3M is

the most aggressive. By strictly looking at the EPS (earnings per share) reported

on stock reports from Yahoo! Finance, the data shows 3M’s numbers to be the

highest. 3M is reporting an EPS of 4.60, while Johnson and Johnson reports 3.80

and Avery Dennison only 2.58.

Conservative Aggressive

AVY JNJ 3M

The remaining portion of 3M’s accounting strategy is a direct result of their

accounting flexibility and key success factors: research and development, brand

image, and product variety and quality. There is a great emphasis on research

and development in order to maintain the competitive advantage of producing

quality products with the latest technology. As a result, 3M’s research and

development expenses and cost of goods sold continue to rise each year. This is

- 16 -

similar to competitors Avery Dennison and Johnson & Johnson. Because 3M

produces a large amount of different products, inventory strategies are

important. 3M uses the FIFO method to calculate inventory, leading to a

decreases in inventory and steady increases in the net sales/inventory ratios

from 2001 to 2005. Johnson and Johnson also show steady increases in net

sales/inventory.

Owning a significant amount of stock is an incentive that managers face. In May

2005, 3M management was approved of 36.75 million shares of company stock

under the Management Stock Ownership Program (MSOP) while general

employees were approved of only 30 million shares under the General

Employees’ Stock Purchase Plan (GESPP). Compensation for the retirement of

general employees is recognized the date of retirement, and this compensation is

recorded as an expense, lowering the net income of the company. Since

managers are less likely to retire than general employees, managers owning

more stock will decrease expenses, resulting in higher net income.

3M changed its accounting policy regarding stock-based compensation. Pro

forma amounts for stock options are based on their fair value, net of tax,

recognizing the expense over the vesting period of the stock award. “Effective

with the May 2005 annual MSOP grant, the Company changed its vesting period

from one to three years, which results in compensation expense under the May

2005 annual grant being recognized over three years”. The impact of the

change in vesting period was that it led to a decrease in pro forma stock

compensation in 2005 from 2004.

From looking at 3M’s quarterly reports, the company’s policies have been mostly

realistic in the past. Revenues as well as expenses continue to rise at a steady

rate from quarter to quarter, and net income continues to rise as revenues

exceed expenses. Additionally, accounts receivable is steadily increasing,

- 17 -

meaning 3M is not overstating their net income from not reporting unearned

revenues. However, by using the FIFO method to account for inventory, short-

term assets have been understated, causing an understatement of net income

Screening Ratio Analysis

This section displays and discusses the key ratios for 3M (MMM) other public

competitors, which are Johnson and Johnson (JNJ) and Avery Dennison Corp.

(AVY). In the following sections, a few of the ratios will not be presented. This

is due to the fact that 3M did not thoroughly disclose its financials; and JNJ and

AVY had very poor disclosure. Most of the figures from JNJ and AVY had to be

found in the un-audited Annual Reports, thus there could be some potential

financial unbalance.

3M Co. Revenue 2001 2002 2003 2004 2005 Net Sales/ Cash from Sales 1.18 1.18 1.17 1.16 1.12 Net Sales/ Net Acc. Rec. 6.47 6.46 6.72 7.17 9.57 Net Sales/ Unearned Revenue N/A N/A N/A N/A N/A Net Sales/ Warranty Liability N/A N/A N/A N/A N/A Net Sales/ Inventory 7.68 8.46 10.04 10.55 12.57

Net Sales/ Cash from Sales

1.061.08

1.11.121.141.161.18

1.21.221.24

2001 2002 2003 2004 2005

3MAVYJNJ

Net Sales/ Cash from Sales are fairly steady between 3M and JNJ until 2003, at

which time they went opposite ways. The reason for the deviation of 3M from

- 18 -

the other two companies is that it is trying to branch away from accounts

receivables. This will reduce the likelihood of an increase in doubtful accounts.

However, being that 3M is at the top of these fields, it has that luxury, whereas

the other two companies need to allow more sales on account to increase their

overall sales.

Net Sales/ Net Accounts Rec.

02468

1012

2001 2002 2003 2004 2005

3MAVYJNJ

Net Sales/ Net Accounts Receivables exemplify what was stated about the

previous graph. On this particular graph, the higher the point the more

separation there is between Net Sales and Net Accounts Receivables.

Net Sales/ Inventory

0

5

10

15

2001 2002 2003 2004 2005

3MAVYJNJ

What we can see from the Net Sales/ Inventory graph above is that all three

companies in year one either had differing predictions on sales or were unclear

on how much inventory to keep on hand. Either way, over the next few years,

- 19 -

they have all come to congruence on what is an acceptable level of inventory to

keep on hand for the market.

3M Co. Expense 2001 2002 2003 2004 2005 Sales/ Assets 1.1 1.07 1.04 0.97 1.32 CFFO/ OI 2.15 1.52 1.57 1.43 1.33 CFFO/ NOA N/A N/A N/A N/A N/A Total Accruals/Change in Sales N/A N/A N/A N/A N/A Pension Exp/ SG&A N/A N/A 0.04 0.08 0.07 Other Employment Exp/ SG&A N/A N/A 0.02 0.03 0.02

Sales/ Assets

00.20.40.60.8

11.21.4

2001 2002 2003 2004 2005

3MAVYJNJ

Sales/ Assets is the best measure for Total Asset Turnover. This indicates if a

company is generating enough business (sales) for the size of its asset

investments. 3M has actually had a great turnover this last period. You can tell

this because their ratio shot up from where it was a year before. On this graph,

a higher number means the company’s sales are that much greater than its

assets. Thus, AVY already started out with higher ratios but saw either lower

sales or a higher increase in assets for a few years and is now rebounding. JNJ

has the lowest ratio numbers, meaning that its sales are not much greater then

the assets it retains. They are slightly up and down and are in a downward

- 20 -

trend now; meaning for the total assets they have they should be having higher

sales but are not. 3M, however, was looking fairly well in 2001 and slowly went

down. Now this is not a bad thing. What happened was they took on more

assets (purchases & buying other companies), thus decreasing the ratio in the

short term. However, in the long run, they have had a bumper year of sales

potentially due to the increase in assets.

CFFO/OI

0

0.5

1

1.5

2

2.5

2001 2002 2003 2004 2005

3MAVYJNJ

With this grouping of Cash Flows from Operations/Operating Income ratios being

so close, there is no real discernable quality between the companies. After the

one jump by AVY in 2002, AVY immediately came back down to level; thus it

would be considered an “Outlier” in the grouping. The graph is showing that all

three of the companies CFFO is more dependent upon the OI.

Consumer and Office 2001 2002 2003 2004 2005 Sales 2817 2444 2607 2861 2986 OI 576 454 448 542 576

- 21 -

0500

10001500200025003000

$ Mill.

2001 2002 2003 2004 2005Years

Consumer & Office

3M SalesAVY Sales3M OIAVY OI

From the graph, 3M has been consistently climbing with it sales. It had one drop

in 2002, but that was an effect most industries saw as a result of “9-11”. 3M’s

operating income has also remained fairly constant and has regained its position

in 2005 from where it was in 2001 pre 9-11. Where as AVY stayed off the drop

from “9-11” but then took a significant drop from 2002 to 2003. They have since

leveled off and remain consistent.

Healthcare 2001 2002 2003 2004 2005 Sales 3301 2560 3995 4230 4373 OI 753 900 1027 1123 1215

0100020003000400050006000

$ Mill.

2001 2002 2003 2004 2005

Years

Health Care

3M SalesJNJ Sales

- 22 -

The Health Care segment has been increasingly prosperous for both companies

in terms of sales. However, we do know that 3M has seen an increase in its

Health Care OI, but we do not know the OI of JNJ due to lack of reporting

figures. In general terms, JNJ has been out performing 3M in the Health care

segment, and it is also more highly invested in the field. Thus, the increase in

the Health Care field has benefited JNJ more, but is probably about equal based

on degree of investment with each company.

The Pension and Other Employee expenses were not reported for either AVY or

JNJ. This was because most financial figures had to be found on these two

companies from their Annual Reports, which are composed to make the company

look its best. Thus, not as much or accurate info has been provided, where as

with the 10-K, which is SEC regulated/ overseen, the numbers must be audited

and provide for the most part in either figure or footnote terms.

Potential Red Flags

To properly evaluate the situation of 3M “Red Flags” we went through their past

10-Ks and their Annual Reports. There were no discernable problems regarding

their reporting. Furthermore, all figures were properly noted and summarized

the changes and effects. For example, the way they reported that “Retirement

Obligations” changed, they stated the cumulative change to net income after tax

and gave a brief summary for the change and why they changed. This would

allow a true investor to easily track down the FASB Interpretation for themselves

and compare the findings to that of the reported figures shown in the 10-K. The

only going concern for 3M would be the fact that it is a Global Conglomerate.

This means that there are potentials for errors, being that they are spread over

60 countries, all of which have their own standards for accounting. Being that

- 23 -

3M is a U.S. company, all of the discrepancies should be filtered out before the

official issuance of a 10-K. But it adds in even more wiggle room for accounting

figures and estimates. Price Waterhouse Cooper was the accounting firm that

preformed 3M’s audits the last few years.

Undoing Accounting Distortions

We found no real accounting distortions that would need altering or adjusting.

The accounting policies that 3M uses make the financial statements very

transparent with no hidden distortions.

- 24 -

Ratio Analysis and Forecast Financials:

The purpose of this section is to perform financial ratio analysis on 3M which will

allow for the examination of the effectiveness of the firm’s strategy over time.

Computing 3M’s financial ratios will determine where the companies underlying

strengths and weaknesses are located. These financial ratios are extremely

important to investors and stockholders so they can utilize this information for

future investment decisions This section will also present the cross sectional

analysis of 3M’s top competitors in the industry. This information will allow us to

bench mark individual competitors as well as diagnose and compute an industry

average. The calculation of the industry average will present an excellent

comparison for 3M’s position in the industry compared to competitors and the

industry as a whole. The final part of this section is to perform a ten year

forecasting model of 3M’s financial statements. This forecasting model will

provide an accurate estimation of the firm’s future growth and earnings.

Financial Ratio Analysis

Liquidity Liquidity Ratios 2001 2002 2003 2004 2005 Current Ratio 1.4 1.36 1.52 1.44 1.36 Quick Asset Ratio .69 .71 .90 .91 .75 A/R turnover 6.47 6.46 6.72 7.17 7.46 Days 56.43 56.48 54.33 50.93 48.94 Inventory Turnover 4.18 4.40 5.11 5.25 4.80 Days 87.23 82.96 71.39 69.53 76.02 Working Capital Turnover

8.98 10.19 6.91 7.55 11.28

- 25 -

3M has an overall positive liquidity analysis with just the current ratio showing a

negative impact. The current ratio from 2001 to 2003 showed a steady increase

in current assets as well as a small increase in current liabilities. After 2003,

there was a huge increase in current liabilities compared to the current assets,

causing the current ratio to decline. The quick asset ratio provided information

showing 3M’s ability to manage their debt. From 2001 to 2004 there was a

steady increase in current liabilities as well as quick assets. In 2005, 3M used a

substantial amount of cash to payoff their current debt, causing the ratio to

decline. The steady incline in accounts receivable turnover shows that overall

sales grew at a greater rate than accounts receivable, meaning 3M’s days sales

outstanding declined by approximately seven days. There was also a steady

incline in inventory turnover, until a decrease in 2005. This is a direct effect of

3M’s inventory decreasing through 2004 then increasing dramatically in 2005.

Furthermore, cost of goods sold gradually increased due to economic factors

such as inflation. Even though there was the decrease in 2005, there was an

overall decrease in days supply of inventory by approximately eleven days.

Finally, there was no foreseeable trend in working capital turnover. Sales

showed steady growth while working capital showed sporadic changes in the five

years.

Profitability and Operating Expense Ratios Profitability Ratios

2001 2002 2003 2004 2005

Gross Profit Margin

45.50% 47.98% 49.07% 50.24% 50.96%

Operating Expense Ratio

31.89% 29.33% 28.71% 27.36% 27.29%

Net Profit Margin 8.91% 12.09% 13.18% 14.94% 15.11% Asset Turnover 1.10 1.07 1.04 .97 1.03

- 26 -

2001 2002 2003 2004 2005 Return on Assets 9.79% 12.88% 13.65% 14.44% 15.59% Return on Equity 23.50% 32.94% 30.48% 28.81% 31.67%

Gross profit margin, operating expense ratio, and net profit margin are all

measures of operating efficiency, and they all showed positive results for 3M’s

operations. There was a steady year to year increase in gross profit margin as

well as 5% increase overall. Operating expenses had a year to year decrease as

a percent of sales and a 4% decrease overall. Net profit margin increased every

year due to increases in net income as a percent of sales. Net income has nearly

doubled in the last five years as sales showed steady growth.

Asset turnover declined steadily from 2001 to 2004 and increased in 2005, but

there was still an overall negative impact. In 2001, for every dollar invested in

assets, there is $1.10 in sales compared to $1.03 in 2005. Return on assets

shows favorable impact because of net income increasing at a greater rate than

assets, and return on equity also shows favorable impact as it increased

approximately 8% from 2001 to 2005. Also, every year until 2004, 3M reports a

large “accumulative other comprehensive income loss” (Stockholder’s equity,

balance sheet). This creates a larger stockholder’s equity total in 2004, causing

the return on equity to decrease.

Capital Structure Capital Structure Ratios

2001 2002 2003 2004 2005

Debt to Equity Ratio

1.40 1.56 1.23 1.00 1.03

Times Interest Earned

17.90 37.26 43.58 65.45 59.99

Debt Service 2.85 3.97 3.99 3.94 3.65

- 27 -

The capital structure ratios show that 3M finances its operations efficiently. The

debt to equity ratio shows that 3M has gone from more credit risk to less risky,

meaning there is a better possibility of satisfying interest and debt repayment.

In 2001, there was $1.40 used for debt for every $1.00 of equity compared to

$1.03 in 2005. The overall increase in times interest earned indicates that there

is a greater possibility to pay off interest charges for current and long term

liabilities. More cash is provided by operations to cover annual installment

payments on long term liabilities due to the overall increase in debt service

margin.

Other Ratios and Growth Rates

Other Ratios and Growth Rates

2001 2002 2003 2004 2005

EBITDA / Sales 20.61% 24.09% 25.37% 27.56% 27.90% NOPAT / Sales 9.79% 12.74% 13.77% 15.37% 15.66% R&D / Net Income 75.80% 54.23% 45.86% 39.93% 38.82% IGR 7.92% 16.79% 17.36% 17.97% 18.94% SGR 19.01% 42.95% 38.75% 35.86% 38.47%

EBITDA to sales and NOPAT to sales both show a favorable steady increase over

the past five years. R&D to net income has been decreasing due to less

investing in the research and development of the company. There is consistency

in the internal growth rate (IGR) from 2002 to 2005, but in 2001 the IGR is

substantially lower due to the low return on equity of that year. This low

amount in 2001 for IGR is reflected by the low amount for the sustainable

growth rate (SGR) because IGR is used in the calculation of SGR. The distinction

between IGR and SGR is that the debt to equity ratio is used in the calculation of

- 28 -

SGR, and the trends from 2001 to 2005 in SGR are similar to the debt to equity

trends. The overall increase in the SGR means that 3M is growing while keeping

its profitability and financial policies unchanged.

Cross Sectional Analysis

Liquidity Ratios

The liquidity ratios of a company allow us to determine if a company can meet its

obligations now or sometime in the near future. The ratios used in our analysis

include current ratio, quick asset ratio, receivables turnover, inventory turnover,

and working capital turnover.

Current Ratio

3M Avery

Johnson & Johnson

Industry Average

2001 1.39 1.03 2.3 1.67

2002 1.36 0.94 1.68 1.31

2003 1.52 0.96 1.71 1.34

2004 1.44 1.11 1.96 1.54

2005 1.36 1.02 2.48 1.75

- 29 -

Current Ratio

0

0.5

1

1.5

2

2.5

3

2001 2002 2003 2004 2005

Year

Ratio

3M

Avery

Johnson & Johnson

Industry Average

The current ratio allows us to determine how much cash will be available to pay

debts that are due (about.com). In most cases, a ratio of one or greater means

that a firm is able to handle its current liabilities with the cash and other liquid

assets that it has on hand (Palepu et al.). As you can see 3M maintains an

almost steady current ratio anywhere between 1.36 and 1.52. In comparison

with the competition 3M is above Avery, but slightly below Johnson & Johnson

and vary slightly with the industry average.

- 30 -

Quick Asset Ratio

3M Avery

Johnson & Johnson

Industry Average

2001 0.69 0.62 5.11 2.892002 0.71 0.58 1.12 1.72003 0.9 0.57 1.2 0.892004 0.91 0.7 1.42 1.062005 0.75 0.63 1.83 1.23

Quick Asset Ratio

0

1

2

3

4

5

6

2001 2002 2003 2004 2005

Year

Ratio

3MAveryJohnson & JohnsonIndustry Average

The quick asset ratio often referred to as the acid test ratio, shows if a company

is liquid enough to meet its current obligations and is obtained by adding cash,

securities, and accounts receivable and dividing them by current liabilities

(Palepu et. al). 3M manages to stay ahead of Avery from 2001 to 2005, but

remains below Johnson & Johnson and the industry average. This is an important

- 31 -

ratio because it will allow us to determine how high or low the ratio will become

in the years to come, in order to determine profitability.

Accounts Receivable Turnover

3M Avery

Johnson & Johnson

Industry Average

2001 6.47 6.57 6.98 6.782002 6.47 5.74 6.72 6.232003 6.72 5.72 6.37 6.012004 7.17 6.02 6.93 6.482005 7.46 6.34 7.21 6.78

Accounts Receivable Turnover

4.00

4.50

5.00

5.50

6.00

6.50

7.00

7.50

8.00

2001 2002 2003 2004 2005

Year

Ratio


The accounts receivable turnover ratio shows how many times accounts

receivable are collected in the current year. A high ratio indicates good collection

while a low ratio shows that there could be a potential problem with collecting

payments (Palepu et. al). As you can see 3M had a below average turnover in

- 32 -

2001, but from 2002 to 2005 they surpassed the industry average as well as one

of their main competitors Johnson & Johnson. In the future this ratio will be

helpful to show whether or not they are a creditworthy company, should

someone decide to invest.

Inventory Turnover

3M Avery

Johnson & Johnson

Industry Average

2001 4.18 9.59 3.2 6.252002 4.4 8.3 3.16 5.732003 5.11 8.14 3.4 5.772004 5.25 8.66 3.58 6.122005 4.8 8.76 3.52 6.14

Inventory Turnover

2

3

4

5

6

7

8

9

10

11

2001 2002 2003 2004 2005

Year

Ratio


Inventory turnover measures how many times a year a company’s inventory is

turned. Being that inventory is not a very liquid asset a high number is generally

- 33 -

good depending on the industry average (about.com). From 2001 to 2005, 3M

remained below average in the range of 4.18 to 5.25.

Working Capital Turnover

3M Avery

Johnson & Johnson

Industry Average

2001 8.98 121.9 3.09 62.52002 10.19 -52.19 4.64 -25.282003 6.91 -84.89 4.38 -40.262004 7.55 34.28 3.54 18.912005 11.27 167.39 2.69 85.04

Working Capital Turnover

-120

-70

-20

30

80

130

180

2001 2002 2003 2004 2005

Year

Ratio


Working capital turnover is computed by dividing sales by working capital and is

a measure of how a company uses its working capital to generate sales and is a

strong measure of financial stability (investopedia.com). As you can see from

- 34 -

above, 3M and Johnson & Johnson stayed close together throughout the five

year period staying above average maintaining steady numbers. Avery took a

nose dive from 2001 to 2003, but later rebounded to regain strength in 2005

Profitability Ratios and Operating Ratios

The profitability ratios of a company allow us to measure whether or not a firm is

generating adequate income. These are used to evaluate operating efficiency,

asset productivity, rate of return on assets and the return on equity.

There are three ratios used to evaluate operating efficiency which include gross

profit margin, operating expense ratio, and net profit margin.

Gross Profit Margin

3M Avery

Johnson & Johnson

Industry Average

2001 45.50% 32.60% 70.40% 51.50%2002 47.90% 32.20% 71.20% 51.20%2003 49.10% 30.60% 70.90% 50.80%2004 50.20% 29.60% 71.70% 50.70%2005 50.90% 29.60% 72.40% 51.00%

- 35 -

Gross Profit Margin

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

2001 2002 2003 2004 2005

Year

Ratio


Gross profit margin is a percentage of gross profit divided by sales for the

current year. A higher percentage indicates that a company is operating

efficiently, but a significant change in the percentage could indicate potential

accounting problems (about.com). The industry average in this case sits right at

50 percent, and 3M gradually increases its efficiency from 2001 to 2005 to meet

the industry average in 2005.


3M Avery

Johnson & Johnson

Industry Average

2001 31.90% 21.80% 34.80% 28.30% 2002 29.30% 21.70% 33.70% 27.70% 2003 28.70% 21.70% 33.80% 27.80% 2004 27.40% 20.80% 33.50% 27.20% 2005 27.30% 20.70% 33.40% 27.10%

- 36 -


10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

2001 2002 2003 2004 2005

Year

Ratio


The operating expense ratio is a percentage measure of how much of the income

is being used to pay expenses relating to operations and is calculated by dividing

selling & administrative expenses by sales. A lower percentage indicates a

greater profit for investors. 3M started above average in 2001 and continued this

until 2004 when they fell to just above the industry average at 27.30%. Avery on

the other hand had the best operating efficiency of the three having a low of

20.70%.

Net Profit Margin

3M Avery

Johnson & Johnson

Industry Average

2001 8.90% 6.40% 17.50% 12.00%2002 12.10% 6.10% 18.20% 24.30%2003 13.20% 5.60% 17.20% 11.40%2004 14.90% 5.30% 17.90% 11.60%2005 15.10% 4.10% 20.60% 12.40%

- 37 -

Net Profit Margin

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

2001 2002 2003 2004 2005

Year

Ratio


The net profit margin of a company shows how much profit a company makes

off of every dollar in revenue it generates (about.com). It is computed by taking

net income and dividing it by sales. Depending on the industry a higher net profit

margin means a higher profit. 3M gradually increases their net profit margin from

2001 to 2005 going from 8.90 to 15.10, meaning that in 2005 about 15 cents

were made in profit.

Asset Turnover Ratio

3M Avery

Johnson & Johnson

Industry Average

2001 1.1 1.31 0.84 1.062002 1.07 1.15 0.9 1.032003 1.04 1.16 0.87 1.022004 0.97 1.21 0.89 1.052005 1.03 1.3 0.87 1.09

- 38 -

Asset Turnover Ratio

0.7

0.8

0.9

1

1.1

1.2

1.3

1.4

2001 2002 2003 2004 2005

Year

Ratio


The asset turnover ratio is used to see how much revenue of every dollar of

assets a company possesses (about.com). This is calculated by taking sales and

dividing it by total assets, and the higher the number the better. From 2001 to

2003, 3M remained above average, but fell below average in the beginning of

2003 falling to .97 for the beginning of 2004.

Return on Assets

3M Avery

Johnson & Johnson

Industry Average

2001 9.79% 8.40% 14.73% 11.57%2002 12.88% 7.00% 16.27% 11.64%2003 13.65% 6.40% 14.91% 10.66%2004 14.44% 6.40% 15.96% 11.18%2005 15.60% 5.40% 17.94% 11.67%

- 39 -

Return on Assets

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

2001 2002 2003 2004 2005

Year

Ratio


The rate of return on assets measures how much income a company’s

management team can get out of every dollar of assets and is a valuable

assessment of a company to investors (bankrate.com). This is computed using

net income and dividing it by total assets. In this case the higher the percentage

the more profit on assets is being made. 3M has maintained a steady growth

from 2001 to 2005 going from 9.79% to 15.60%.

Return on Equity

3M Avery

Johnson & Johnson

Industry Average

2001 23.45% 15.00% 21.65% 18.33%2002 32.94% 18.10% 22.22% 20.16%2003 30.48% 20.30% 21.41% 20.86%2004 28.81% 24.30% 22.19% 23.25%2005 31.68% 26.20% 23.35% 24.78%

- 40 -

Return on Equity

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

2001 2002 2003 2004 2005

Year

Ratio

3M

Avery

Johnson & Johnson

Industry Average

The return on equity is used to see how much a company earned in comparison

to equity on the financial statements while showing how management is

investing the shareholders’ funds (about.com). This is computed by taking net

income and dividing it by total owners’ equity. 3M had a tremendous gain from

2001 to 2002 going from 23.45% to 32.94% and then gradually decreasing to

28.81% in 2004.

Capital Structure Ratios


3M Avery

Johnson & Johnson

Industry Average

2001 1.4 2.13 0.59 1.362002 1.56 2.46 0.79 1.6252003 1.23 2.12 0.8 1.462004 1 1.84 0.68 1.262005 1.03 1.78 0.53 1.155

- 41 -


0

0.5

1

1.5

2

2.5

3

2001 2002 2003 2004 2005

Year

Ratio


Times Interest Earned Ratio

3M Avery

Johnson & Johnson

Industry Average

2001 17.9 8.17 49.44 28.812002 37.26 9.35 50.44 29.92003 43.58 6.72 41.2 23.962004 65.45 7.39 55.45 31.472005 59.99 7.34 188.94 98.14

- 42 -

Times Interest Earned

0

20

40

60

80

100

120

140

160

180

200

2001 2002 2003 2004 2005

Year

Ratio


Debt Service Margin

3M Avery

Johnson & Johnson

Industry Average

2001 2.85 1.85 4 2.932002 3.97 2.27 4.04 3.162003 3.99 1.84 3.59 2.722004 3.94 3.95 4.34 4.152005 3.65 1.21 5.89 3.55

- 43 -

Debt Service Margin

1

1.5

2

2.5

3

3.5

4

4.5

5

5.5

6

2001 2002 2003 2004 2005

Year

Ratio


Financial Statement Forecasting Methodology *Forecasted Financial Statements are in Appendix Overview

Selecting the proper forecast method is vital for the accuracy of the Pro- Forma

Statements. The statements are being composed of estimates and if those

estimates are off they will continually compound for each new year. So it is

important to get the estimations as close as possible and spend the most time in

consideration of some of the key accounts, such as: Cash, Investments, Sales,

COGS and for 3M R& D.

We evaluated our forecast numbers primarily off the past five year performance.

To do this we took the average of the last five years, and then we took the

- 44 -

change over the last five years. To get a net percentage change we divided the

change over the average. This gave us net percentages for each account. If the

percentage was .99% or less we went ahead and used the five year average, the

five year average plus growth or just growth. For those accounts with much

fluctuation we said there was “No Trend”. It is better to not forecast these then

make assumptions on the estimates based off volatile numbers. Example of

forecasting:

Expressed in Millions 2001/12/31 2002/12/31 2003/12/31 2004/12/31 2005/12/31 AVG.

Cash and cash equivalents $616 $618 $1,836 $2,757 $1,072 $1,380

01 to 02 02 to 03 03 to 04 04 to 05 AVG. AVG. % 2 1218 921 (1685) $114 8.26%

114/1380 = .0826 = 8.26%

This is how we went about evaluating most of the accounts for all the

statements. Once we came up with a proper estimate or growth we did not

change it. We based this decision on that the less estimates you make the less

potential for error, as well as only the first few years are truly foreseeable in this

day and age. For all we know we might be involved in a War in the next five

years or we might have one of the biggest economic booms. So we used the

“Play it Safe” method and left the change the same for each year. We did have

one outlier when it came to this. Accounts Payable on the Balance Sheet we

estimated it to have growth of 2% till 2010; in 2011 it would go up 1% to a 3%

total. We did this because the change was small but we see 3M will be growing

and more cost to go with.

However, it did not make since to use this method for all the accounts. Some

accounts we used ratio analysis to forecast the change. The ratios we used

were:

- 45 -

• Sales/ Receivables Turnover

• COGS/ Inventory Turnover

The reason we used these two ratios rather then our previous method is simple

we felt it yielded more stable numbers.

Limitations

As we discussed earlier one such limitation is that we can not know what the

overall world economy will be like in the future. Nobody knows what is in- store

for our future so it is better to under estimate to give yourself a bit of wiggle

room incase of a problem. If the numbers of the future statements happen to be

better that’s ok then because we necessarily prepared for the worst. Another

limitation to our forecasting is that we used more basic forms of measuring/

assessing growth and change rather then statistical methods. We felt this would

be necessary because the statistical methods do not incorporate the intangibles

that can’t be measured, such as: management, key- personnel.

Conclusion

In conclusion, after forecasting the Financial Statements we can see the

importance not only to potential investors but to management as well. Without

an accurate forecast, management might make the wrong decision on whether

to liquidate, divest, employee product development; whatever managerial

strategy they are looking at for the future. We also se that 3M is a growing

company and the numbers are looking right for success so long as there is no

significant issue with the non-forecasted numbers.

- 46 -

Valuation Analysis:

To better understand the company’s financial position we used a multiple of

valuation methods. These methods included methods of comparables, discount

dividends, discounted free cash flows, residual income, abnormal earnings

growth, and long run residual income perpetuity. These different valuations

provided us with important information on whether 3M was over, under or fairly

valued. We constructed the valuations by using previous financial statements

and pro-forma (forecasted) financial statements. These estimated financial

statements were forecasted ten years into the future.

Methods of Comparables Using the methods of comparables is a basic way to evaluate a company.

However, they lack the depth and company overview the intrinsic methods

provide. The reason they are primarily used is because of the simplicity it takes

to create them. The comparables methods also do not provide a solid basis for

comparing companies. This is because of the discrepancies between companies

in general and also when compared to those in the same industry. However, the

methods are a good initial place to start when evaluating a company. When

evaluating 3M we used six comparable methods: Price/ Earnings Trailing, Price/

Earnings Forward, Price/Book, Dividend/ Price, Price Earnings Growth, and

Enterprise Value/ EBITDA.

We felt the methods of comparables aided our valuation even less because of

3M’s industry. 3M is in the conglomerate industry; therefore, there are a

multitude of companies that differentiate from one another. Johnson & Johnson

(JNJ) and Avery Dennison (AVY) were the two that we used as our comparable

- 47 -

companies. This is because they are direct competitors to 3M; however, they

also have many segments in which 3M does not compete in. Those non-

competitive segments are included in the financial data used to come up with

these methods, thus disrupt the potential accuracy these methods could provide.

EPS BPS PPS SPS

3M 4.6 14.92 78.84 29.83

Price/ Earnings Trailing

MMM 17.14 Industry Average 21.88

MMM EPS 4.6 JNJ 17.45 AVY 26.30 Share Price 100.63 * MMM is omitted from Industry Avg.

The estimated share price of $100.63 would make 3M undervalued in

comparison to the actual price of 78.84.

Price/ Earnings Forward


MMM EPS 4.6 JNJ 16.33 AVY 16.96 Share Price 76.57 * MMM is omitted from Industry Avg.

The estimated share price of $76.57 would make 3M overvalued in comparison

to the actual price of 78.84. This method was the most effective in comparison

to the actual price per share.

- 48 -

Price/ Book


MMM BPS 14.92

JNJ 4.72 AVY 3.82 Share Price 63.71 * MMM is omitted from Industry Avg.


to the actual price of 78.84.

Dividend/ Price


MMM PPS 78.84 JNJ 2.30 AVY 2.60 Share Price 193.16 * MMM is omitted from Industry Avg.

The estimated share price of $193.16 would make 3M undervalued in

comparison to the actual price of 78.84. This method was very different from

the actual price per share so we considered the method to be an outlier and

disregarded the results.

Price Earnings Growth


MMM SPS 29.83 JNJ 1.76 AVY 1.50 Share Price 48.62 * MMM is omitted from Industry Avg.

- 49 -


to the actual price of 78.84. This method was very different from the actual

price per share so we considered the method to be an outlier and disregarded

the results.

Enterprise Value/ EBITDA


MMM EPS 4.6

JNJ 11.37 AVY 10.98 Share Price 51.41 * MMM is omitted from Industry Avg.


to the actual price of 78.84.

WACC Weighted Average Cost of Capital

To begin the process of formulating the intrinsic valuations, we first had to

calculate the weighted average cost of capital (WACC). The five components of

the weighted average cost of capital are Vd, value of debt; Ve, value of equity;

Vf*, value of the firm; Ke, cost of equity; Kd, cost of debt. The relationship

between the five components can be seen in the following formula:

Vd Ve

WACC = ------ (Kd (1-T)) + ------ (Ke)

Vf Vf

• Vf = Vd + Ve

• T = Tax Rate

- 50 -

Estimating Cost of Debt

To estimate the cost of debt, we had to search the 10-Ks of 3M to find the

interest rates that were associated with the different liabilities. We broke down

the liabilities into short term and long term debt and matched them with the

applicable interest rates. To find the long term interest rate, we took the

average between all the long term interest rates that we found in the 10-K. We

then found the weight that each liability held in relationship to the total liabilities.

We then multiplied the interest rate by the established debt weight to find the

cost of debt of each liability. We then took the summation of all the cost of

debts to formulate the weighted average cost of debt. Our weighted average

cost of debt (WACD) is 4.66%.

Estimating Cost of Equity

We calculated our cost of Equity by using the capital asset pricing model (CAPM).

The formula for the CAPM is:

Ke= rf +β(rm-rf)

There are steps that go into computing the CAPM in order to obtain the cost of

equity. We began by finding the historical stock prices for 3M using the monthly

closing prices. We factored in the dividends and the stock splits that occurred in

September 2003. We took this into account because when there is a split you

have to convert the dividends and the stock prices to reflect the data in the

regression analysis, which we did later. The next step in the CAPM valuation is

to get the monthly returns for 3M. This is done by dividing the most recent

month’s closing price by the previous month’s closing price and subtracting the

total from 1. This process is repeated for the last five years. Our next step was

to obtain the closing prices for the Standard & Poor’s 500 stock index for the last

- 51 -

five years. We repeat the same process for to find the Standard & Poor’s returns

that we used to find the 3M returns. The next step in the process is to find the

monthly interest rates from the St. Louis Federal Reserve. We took the monthly

interest rates for the three month, one year, five year, and ten year rates and

converted them to monthly risk free rates. To find the monthly risk free rate, we

divided the annual interest rate by 100, and we took this answer and divided it

by 12. Now that we have the Standard & Poor’s returns, we take those and

subtract out the monthly risk free rates to get our market premiums. The next

step in our analysis was to perform a regression analysis. We did this by taking

M’s returns and market premiums and using Microsoft Excel to a 60, 48, 36, and

24 month regression analysis. The numbers that we are mainly concerned with

from the monthly regression analysis are the adjusted r-squared and the market

premium. Our final step is to take the adjusted r-squared and market premiums

and use them to compute the cost of equity. In order to get the cost of equity,

we took the market premium from the regression, which is our beta, multiplied it

times our historical risk premium of 7%, and added it to the adjusted r-squared

to end up with the cost of equity. These steps are repeated to compute the costs

of equity for 60, 48, 36, and 24 months. For our analysis, we used the 5-year

constant maturity rate Treasury bill monthly rates because they yielded the most

constant set of r-squared from our regression analysis. We used the cost of

equity (ke), which is 9.1%, from the 60 month regression analysis because that

was the highest r-squared. Because 3M is diversified in its operations it does not

follow the market trend. This results in a 14% systematic risk and an 86% firm

risk, which means that we will have to perform a large sensitivity analysis for all

of our intrinsic valuation models.

Computing WACC

Now that we have our estimated cost of equity and cost of debt, we can now

compute our weighted average cost of capital.

- 52 -

Vd Ve

WACC = ------ (Kd (1-T)) + ------ (Ke)

Vf Vf

Where:

Vd= 10,413,000,000

Ve= 61,103,722,503

Kd= 4.66%

Ke= 9.10%

T= 35%

10,413,000,000 61,103,722,503

WACC = ------------------------- (.046 (1-.035)) + -------------------------

(.091)

71,516,722,503 71,516,722,503

WACC= 8.22%

Discounted Dividends

The discounted dividends valuation model uses the Ke, growth rates and

forecasted future dividends to value the firm. The first step in the process was

to calculate the dividends per share for the previous five years and to forecast

dividends for the next ten years into the future. During the previous five years,

the dividends per share have increased by roughly $0.10 to $0.15 each year. We

maintained this consistency when forecasting the dividends per share for the first

five years and then adjusted to approximately $0.20 for the remaining five years

due to outside economic factors such as inflation. Since we wanted to keep our

forecasts comparable to the amounts of the previous five years we used a

growth rate of zero. We then calculated the present value factor for each

- 53 -

forecasted year and multiplied that amount by the forecasted dividends per

share amount to come up with the present value of future dividends amounts.

The sum of the present value of future dividends was then taken to calculate the

total present value of future dividends. We then added the total present value of

future dividends to the present value of the terminal value to reach our

estimated value of the firm, which ended up being $31.53 per share. However,

this is valued using a zero percent growth rate, and our firm is more likely to

grow at a slow and steady rate. The current market price is quoted at $78.84

per share. Even with our estimated Ke of 9.1%, the discount dividends valuation

shows that our firm is overvalued. We feel that this is not accurate method of

valuing 3M because it is only based on the performance of dividends.

Sensitivity Analysis

Growth 0 0.01 0.02 0.03 0.04 0.05Ke 0.06 49.64 56.05 65.66 81.68 113.71 209.81

0.07 42.02 46.22 52.11 60.94 75.66 105.100.08 36.33 39.23 43.09 48.51 56.63 70.17

0.091 31.53 33.54 36.12 39.54 44.31 51.400.10 28.41 29.94 31.85 34.31 37.59 42.180.11 25.55 26.70 28.11 29.88 32.14 35.160.12 23.18 24.07 25.13 26.43 28.06 30.15

Overvalue <65Undervalue >96Fair Value 65-96

Because 3M is a diversified conglomerate, their stock prices do not move with

the rest of the market in the S&P 500. Therefore, we needed to perform a larger

sensitivity analysis with a greater spread in the Ke and growth rate fields

because the small amount of systematic risk. We found that using a higher

growth rate brings us closer to the actual stock price. The full model is in the

Appendix.

- 54 -

Free Cash Flows

This valuation model is used to estimate the value of the firm by using the

weighted average cost of capital, growth rates, and forecasted cash flows. The

first step in this process is to forecast the cash flows from operations and the

cash flows from investing activities for ten years into the future. We then

subtracted these forecasted cash flows from operations by the cash flows from

investing activities to get the free cash flows of the firm. Next, we discounted

the free cash flows by the weighted average cost of capital to find the present

value of annual cash flows. We then took the sum of these present value cash

flows to reach the total present value of annual cash flows. We continued to use

a growth rate of zero because we believe 3M will continue at a minimal growth

rate remain consistent. We then discounted back the terminal year value by the

weighted average cost of capital to find the present value of this terminal year.

To find the value of the firm, we added the present value of the terminal year to

the total present value of annual cash flows. Subtracting the value of the firm by

the book value of debt gives us the book value of equity, which is divided by the

number of shares outstanding to find the value per share. We found the value

per share to be $49.04, which means 3M is overvalued according to this

valuation model. Due to the estimation of the future free cash flows and the

cost of debt and cost of equity components of the weighted average cost of

capital, we do not believe this model is an accurate determinant of the 3M’s

market value.

- 55 -

Sensitivity AnalysisGrowth 0 0.01 0.02 0.03 0.04 0.05

WACC 0.05 $96.62 $116.59 $149.87 216.44 $416.150.06 $76.34 $88.56 $106.90 137.46 $198.59 $381.970.07 $61.94 $69.96 $81.20 98.05 $126.13 $182.31

0.0824 $49.04 $54.13 $60.85 $70.15 $83.82 $105.940.09 $42.93 $46.89 $51.99 $58.78 $68.29 $82.560.1 $36.36 $39.28 $42.93 $47.62 $53.88 $62.64

0.11 $31.03 $33.23 $35.92 $39.28 $43.61 $49.380.12 $26.62 28.31 30.34 32.83 $35.93 $39.92


Regarding this valuation model, we think the intrinsic value of the firm is fairly

valued. As you can see on the sensitivity analysis, using our weighted average

cost of capital with a growth rate of 4% the value of the firm is nearly identical

to the actual current stock price of 3M.

Residual Income

This valuation’s variables consist of book value of equity per share, earnings per

share, dividends per share and cost of equity. The first step that we did was

take the ending 2006 book value of equity per share and use this number as the

beginning book value of equity per share for 2007. With the 2007 beginning

book value of equity, we were able to add our forecasted earnings per share and

subtract the dividends per share to calculate the ending book value of equity.

This will be the next years beginning book value of equity. This same process is

repeated until you find the ending book value of equity for the final forecasted

year. Next, to find normal income we had to take the pervious year’s book value

of equity and multiply it by our discount rate/cost of equity, which is 9.41%. We

did this same process to find the normal income in all remaining years that were

- 56 -

forecasted. Then we subtracted normal income from earnings per share to find

the residual income and continued the above process for the next ten forecasted

years. We then discounted each year’s residual income back to 2006 to find the

present value of the residual income. Finally, to calculate the estimated value

per share, we added the book value of equity per share at the end of 2006, the

total present values of the residual income, and the present value of the terminal

year. This estimated value per share was calculated as $90.91, which is the

value at the end of 2006. We then had to discount this number back to the

beginning of November 2006 because we cannot recognize unearned income.

This number was estimated to be $89.60, which is slightly above the actual value

of $78.84. Therefore, according to this model, the firm is undervalued.


Growth 0 0.01 0.02 0.03 0.04 0.05

Ke 0.06 158.33 177.71 206.79 225.25 352.17 642.930.07 129.01 141.01 157.81 183.01 225.00 309.000.08 107.45 115.22 125.60 140.12 161.90 198.20

0.091 89.60 94.61 101.04 109.58 121.46 127.890.1 78.17 81.75 86.23 91.98 99.65 110.40

0.11 67.90 70.40 74.75 77.29 82.21 88.760.12 59.54 61.31 63.44 66.04 69.30 73.48


According to the sensitivity analysis, our Ke is slightly too low to reach the

market value, but this value is attainable with a Ke of 11% and a slow and

steady growth rate of 3-4%. Also, this analysis shows the price is more sensitive

with a lower Ke and higher growth rate. We feel this valuation is a more

accurate determinant of 3M’s value than discounted dividends and free cash

flows.

- 57 -

Long-Run Average Residual Income Perpetuity

The last valuation we used to value 3M is the long run average residual income

perpetuity that is based on the P/B ratio. The long run average residual income

formula that we used was:

P = BVE + BVE ((ROE – Ke) / (Ke – g))

The book value of equity per share that we used was 12.64. The ROE was found

by dividing the forecasted earnings per share by the book value of equity per

share, then taking the average of all of them. The average ROE ended up being

31.71%. We took the growth rate from the other valuation models. We feel

that because 3M is a very large corporation so they aren’t going to be growing at

a very substantial growth rate. For this reason we chose to use a 0-5% growth

rate on the sensitivity analysis. For the cost of equity we decided to continue to

use our estimated cost of equity of 9.41%. Our next step was to plug the

numbers the numbers into the formula and compute the estimated intrinsic

value. We found the estimated value of the stock to be $47.36 per share. This

valuation is not anywhere close to the residual income model which is $89.60.

Our critical sensitivity analysis that we chose to use was the growth/Ke model.

As you can see with the sensitivity analysis that when the growth rate gets

smaller and with a smaller Ke the estimated value of stock gets larger. We

believe that our cost of equity is too small to begin with so with a larger cost of

equity our estimated price per share will decrease.

Overvalue <65

Undervalue >96

Fair Value 65-96

- 58 -


Growth 0 0.01 0.02 0.03 0.04 0.050.05 $83.49 $83.63 $83.77 $83.91 $84.06 $84.20

0.06 $70.13 $70.22 $70.32 $70.41 $70.51 $70.60

0.07 $60.58 $60.65 $60.72 $60.78 $60.85 $60.92

0.08 $53.42 $53.47 $53.52 $53.57 $53.62 $53.67

Ke 0.091 $47.36 $47.40 $47.44 $47.47 $47.51 $47.55

0.1 $43.39 $43.42 $43.45 $43.48 $43.51 $43.54

0.11 $39.75 $39.77 $39.80 $39.82 $39.84 $39.87

0.12 $36.71 $36.73 $36.75 $36.77 $36.79 $36.80

Abnormal Earnings Growth

Abnormal Earnings Growth (AEG) is a valuation model used to value a company

by the re-investment opportunities of the dividends. The first part involves

obtaining the forecasted earnings per share as well as the forecasted dividends

per share for the next ten years to be used in our computations. Next we used

the dividends per share for 2006 and then multiplied them by our cost of equity

(Ke) to obtain an estimate of re-investing dividends. In order to obtain

cumulative dividend earnings for 2007, we took the sum of the earnings per

share and the re-invested dividends. After this we had to grow the earnings per

share from 2006 to 2007 by multiplying it times 1 plus the cost of equity to arrive

at normal earnings. Our next step was to subtract the normal earnings from our

cumulative dividend earnings to finally obtain the abnormal earnings growth.

These calculations were done for the next 10 years. Afterwards, each value was

discounted back to the year 2006 to get a total present value of the abnormal

earnings growth. We obtained the average perpetuity by adding together the

2007 earnings per share, the present value of the terminal value, and the total

- 59 -

present value of abnormal earnings growth. We calculated the value per share

at January 2005 by taking our average earnings per share and dividing it by our

capitalization rate. The last step involves taking this price and multiplying it

times 1 plus the cost of capital, raised to 1.91667. This number was used mainly

because the time elapsed from the end of January 2005 to the beginning of

November 2006 (23 months or 1.91667 years) passed by. This valuation model

showed 3M to be undervalued, and we believe that this model is not very

accurate in relation to the previous models.


Growth 0 0.01 0.02 0.03 0.04 0.05Ke 0.06 271.46 297.39

0.07 193.73 206.80 225.10 252.54 298.29 389.780.08 144.52 151.47 160.75 173.73 193.20 225.66

0.091 108.93 112.53 117.14 123.27 131.80 144.500.1 88.60 90.73 93.38 96.79 101.34 107.71

0.11 71.98 73.14 74.57 76.36 78.66 81.720.12 59.61 60.23 60.97 61.88 63.01 64.470.13 50.83 51.25 51.76 52.40


Our sensitivity analysis showed that this valuation method is very sensitive to the

cost of equity and is very sensitive to the changes in growth. With the dramatic

changes in share prices with our costs of equity, this model would not be an

accurate measure as some of the others.

Altman Z-score

We used the Altman Z-score formula for the calculation of credit risk analysis.

This formula uses multiple weighted ratios based on financial statement

numbers. Once we calculated 3M’s score, it came out to be 3.12, which is above

- 60 -

- 61 -

2.67. Since it is above 2.67, banks and other financial institutions will provide

debt coverage when needed. The Z-score formula is as follows:

Z-score = 1.2[Working Capital/Total Assets] + 1.4[Retained Earnings/Total Assets] +

3.3[EBIT/Total Assets] + .6[Market Value of Equity/Book Value of Liabilities] + 1[Sales/Total

Assets]

Summary of Valuations

After performing the intrinsic valuations, we found that 3M is slightly overvalued.

The average of all the valuations is $65.29 per share, which is low compared to

the actual current value of $78.84. According to the discounted dividends, free

cash flow and long run return on earnings perpetuity models 3M is overvalued.

Also, the residual income model came up with the closest value to 3M’s actual

market price per share with a value per share of $89.60. Furthermore, the

abnormal earnings growth model had the second closest of $108.93. These

values are higher than the actual stock price because 3M’s cost of equity remains

too low, which will drive the estimated stock prices that are based off this value

higher then they should be. One reason we feel that our Ke is too low is

because 3M is a diversified conglomerate, meaning their stock prices do not

move with the rest of the market trend in the S&P 500. This will lead to a 14%

systematic risk, which is too small, and an 86% firm risk.

Due to the small amount of systematic risk, we were required to perform a larger

sensitivity analysis. By looking at the sensitivity analysis of each model, you can

see that as the cost of equity increases, it leads to a decrease in the estimated

stock price. Another factor that affected these models was the growth rate

because an increasing growth rate will lead to increases in the estimated share

price. From the information in each sensitivity analysis, we confidently feel that

3M is slightly overvalued.

Appendix

Appendix A: Forecasted Balance Sheet

3M Balance Sheet 12/31 Actual Balance Sheet ForecastsExpressed in Millions 2001/12/31 2002/12/31 2003/12/31 2004/12/31 2005/12/31 AVG. Forecast 2006/12/31 2007/12/31 2008/12/31 2009/12/31 2010/12/31 2011/12/31 2012/12/31 2013/12/31 2014/12/31 2015/12/31 ASSETSCURRENT ASSETS:Cash and cash equivalents $616 $618 $1,836 $2,757 $1,072 $1,380 8.26 $1,621 $1,734 $1,854 $1,983 $2,122 $2,269 $2,427 $2,596 $2,777 $2,970Accounts receivable $2,482 $2,527 $2,714 $2,792 $2,838 $2,671 3.33 $2,966 $3,101 $3,244 $3,396 $3,556 $3,725 $3,904 $4,093 $4,293 $4,505Inventories, net $2,091 $1,931 $1,816 $1,897 $2,162 $1,979 $2,250 $2,341 $2,437 $2,536 $2,641 $2,750 $2,863 $2,982 $3,107 $3,236Other current assets $1,107 $983 $1,354 $1,274 $1,043 $1,152 (1.39)Total current assets $6,296 $6,059 $7,720 $8,720 $7,115 $7,182 $8,853 $9,469 $10,129 $10,833 $11,587 $12,394 $13,257 $14,179 $15,166 $16,222Investments $275 $238 $218 $227 $272 $246 Avg. $246 $246 $246 $246 $246 $246 $246 $246 $246 $246Property and equipment, net $5,615 $5,621 $5,609 $5,711 $5,593 $5,630 Avg. $5,630 $5,630 $5,630 $5,630 $5,630 $5,630 $5,630 $5,630 $5,630 $5,630Goodwill $1,012 $1,898 $2,419 $2,655 $3,473 $2,291 26.85 $3,874 $4,322 $4,821 $5,378 $5,999 $6,691 $7,464 $8,326 $9,288 $10,361Intangible assets $238 $269 $274 $277 $486 $309Prepaid pension and postretirement benefits $2,591 $2,905 $2,748 Avg. $2,748 $2,748 $2,748 $2,748 $2,748 $2,748 $2,748 $2,748 $2,748 $2,748Other Assets $1,170 $1,244 $1,360 $527 $669 $994 No TrendTotal Long Term Assets $8,310 $9,270 $9,880 $11,988 $13,398 $10,569 TA-CA $12,922 $13,821 $14,783 $15,812 $16,912 $18,089 $19,348 $20,695 $22,135 $23,676TOTAL ASSETS $14,606 $15,329 $17,600 $20,708 $20,513 $17,751 $21,775 $23,290 $24,911 $26,645 $28,500 $30,483 $32,605 $34,874 $37,302 $39,898

LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Short-term borrowing and current portion of LT debt $1,373 $1,237 $1,202 $2,094 $1,072 $1,396 (5.39) $1,099 $1,126 $1,154 $1,183 $1,213 $1,243 $1,274 $1,306 $1,339 $1,372Accounts payable $753 $945 $1,087 $1,168 $1,256 $1,042 5.85% of CL $201 $215 $230 $247 $264 $282 $302 $323 $345 $369Accrued payroll $539 $411 $436 $487 $469 $468 Avg. $468 $468 $468 $468 $468 $468 $468 $468 $468 $468Accrued income tax $596 $518 $880 $867 $989 $770 12.76 $1,115 $1,257 $1,418 $1,599 $1,803 $2,033 $2,292 $2,585 $2,915 $3,287Other current liabilities $1,248 $1,346 $1,477 $1,455 $1,452 $1,396Total current liabilities $4,509 $4,457 $5,082 $6,071 $5,238 $5,071 28.73% of L&SE $3,442 $3,682 $3,938 $4,212 $4,505 $4,819 $5,154 $5,513 $5,897 $6,307Long Term Debt $1,520 $2,140 $1,735 $727 $1,309 $1,486 (3.55) $2,873 $3,089 $3,332 $3,604 $3,910 $4,253 $4,638 $5,070 $5,554 $6,096Other Liabilities $2,491 $2,739 $2,898 $3,532 $3,866 $3,105 11.07 $3,867 $3,868 $3,869 $3,871 $3,872 $3,873 $3,874 $3,875 $3,876 $3,877TOTAL LIABILITIES $8,520 $9,336 $9,715 $10,330 $10,413 $9,663 $11,980 $12,814 $13,705 $14,659 $15,680 $16,771 $17,938 $19,187 $20,522 $21,950COMMITMENTS AND CONTINGENCIESSHAREHOLDERS EQUITY:Preferred stockCommon stock par value $.01 per share $5 $5 $9 $9 $9 $7 Avg. $7 $7 $7 $7 $7 $7 $7 $7 $7 $7Additional paid-in capital $291 $291 $287 $287 $287 $289 Avg. $289 $289 $289 $289 $289 $289 $289 $289 $289 $289Retained earnings $11,914 $12,748 $14,010 $15,649 $17,358 $14,336 9.49 $17,617 $18,843 $20,155 $21,557 $23,058 $24,662 $26,379 $28,215 $30,179 $32,279Treasury stock ($4,633) ($4,767) ($4,641) ($5,503) ($6,965) ($5,302)Unearned compensation ($286) ($258) ($226) ($196) ($178) ($229) 11.80 ($157) ($138) ($122) ($108) ($95) ($84) ($74) ($65) ($57) ($51)Accumulated other comprehensive income (loss) ($1,205) ($2,026) ($1,554) $132 ($411) ($1,013) No TrendTotal shareholders equity $6,086 $5,993 $7,885 $10,378 $10,100 $8,088 $9,795 $10,477 $11,206 $11,986 $12,820 $13,712 $14,667 $15,688 $16,780 $17,947TOTAL LIABILITIES AND SHAREHOLDERS EQUITY $14,606 $15,329 $17,600 $20,708 $20,513 $17,751 $21,775 $23,290 $24,911 $26,645 $28,500 $30,483 $32,605 $34,874 $37,302 $39,898Shares Outstanding 782,607,272 780,391,362 784,117,360 773,518,281 754,538,387 775,034,532 No Trend 775,034,532 775,034,532 775,034,532 775,034,532 775,034,532 775,034,532 775,034,532 775,034,532 775,034,532 775,034,532

- 62 -

Appendix B: Common Size Forecasted Balance Sheet

3M Balance Sheet 12/31 Actual Balance Sheet ForecastsExpressed in Millions 2001 2002 2003 2004 2005 AVG. 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ASSETSCURRENT ASSETS:Cash and cash equivalents 4.22% 4.03% 10.43% 13.31% 5.23% 7.44% 7.44% 7.44% 7.44% 7.44% 7.44% 7.44% 7.44% 7.44% 7.44% 7.44%Accounts receivable 16.99% 16.49% 15.42% 13.48% 13.84% 15.24% 13.62% 13.32% 13.02% 12.74% 12.48% 12.22% 11.97% 11.74% 11.51% 11.29%Inventories, net 14.32% 12.60% 10.32% 9.16% 10.54% 11.39% 10.33% 10.05% 9.78% 9.52% 9.27% 9.02% 8.78% 8.55% 8.33% 8.11%Other current assets 7.58% 6.41% 7.69% 6.15% 5.08% 6.58%Total current assets 43.11% 39.53% 43.86% 42.11% 34.69% 40.66% 40.66% 40.66% 40.66% 40.66% 40.66% 40.66% 40.66% 40.66% 40.66% 40.66%Investments 1.88% 1.55% 1.24% 1.10% 1.33% 1.42% 1.13% 1.06% 0.99% 0.92% 0.86% 0.81% 0.75% 0.71% 0.66% 0.62%Property and equipment, net 38.44% 36.67% 31.87% 27.58% 27.27% 32.37% 25.86% 24.17% 22.60% 21.13% 19.75% 18.47% 17.27% 16.14% 15.09% 14.11%Goodwill 6.93% 12.38% 13.74% 12.82% 16.93% 12.56% 17.79% 18.56% 19.35% 20.18% 21.05% 21.95% 22.89% 23.88% 24.90% 25.97%Intangible assets 1.63% 1.75% 1.56% 1.34% 2.37% 1.73%Prepaid pension and postretirement benefits 12.51% 14.16% 13.34% 12.62% 11.80% 11.03% 10.31% 9.64% 9.01% 8.43% 7.88% 7.37% 6.89%Other Assets 8.01% 8.12% 7.73% 2.54% 3.26% 5.93%Total Long Term Assets 56.89% 60.47% 56.14% 57.89% 65.31% 59.34% 59.34% 59.34% 59.34% 59.34% 59.34% 59.34% 59.34% 59.34% 59.34% 59.34%TOTAL ASSETS 100% 100% 100% 100% 100% 100.00% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Short-term borrowing and current portion of LT debt 9.40% 8.07% 6.83% 10.11% 5.23% 7.93% 5.05% 4.84% 4.63% 4.44% 4.26% 4.08% 3.91% 3.75% 3.59% 3.44%Accounts payable 5.16% 6.16% 6.18% 5.64% 6.12% 5.85% 0.93% 0.93% 0.93% 0.93% 0.93% 0.93% 0.93% 0.93% 0.93% 0.93%Accrued payroll 3.69% 2.68% 2.48% 2.35% 2.29% 2.70% 2.15% 2.01% 1.88% 1.76% 1.64% 1.54% 1.44% 1.34% 1.25% 1.17%Accrued income tax 4.08% 3.38% 5.00% 4.19% 4.82% 4.29% 5.12% 5.40% 5.69% 6.00% 6.33% 6.67% 7.03% 7.41% 7.81% 8.24%Other current liabilities 8.54% 8.78% 8.39% 7.03% 7.08% 7.96%Total current liabilities 30.87% 29.08% 28.88% 29.32% 25.54% 28.73% 15.81% 15.81% 15.81% 15.81% 15.81% 15.81% 15.81% 15.81% 15.81% 15.81%Deferred income taxes 10.41% 13.96% 9.86% 3.51% 6.38% 8.82% 13.20% 13.26% 13.37% 13.53% 13.72% 13.95% 14.23% 14.54% 14.89% 15.28%Long-term debt, net of current portion 17.05% 17.87% 16.47% 17.06% 18.85% 17.46% 17.76% 16.61% 15.53% 14.53% 13.58% 12.70% 11.88% 11.11% 10.39% 9.72%TOTAL LIABILITIES 58.33% 60.90% 55.20% 49.88% 50.76% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02%COMMITMENTS AND CONTINGENCIESSHAREHOLDERS EQUITY:Preferred stockCommon stock par value $.01 per share 0.03% 0.03% 0.05% 0.04% 0.04% 0.04% 0.03% 0.03% 0.03% 0.03% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02%Additional paid-in capital 1.99% 1.90% 1.63% 1.39% 1.40% 1.66% 1.33% 1.24% 1.16% 1.08% 1.01% 0.95% 0.89% 0.83% 0.77% 0.72%Retained earnings 81.57% 83.16% 79.60% 75.57% 84.62% 80.90% 80.90% 80.90% 80.90% 80.90% 80.90% 80.90% 80.90% 80.90% 80.90% 80.90%Treasury stock -31.72% -31.10% -26.37% -26.57% -33.95% -29.94% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Unearned compensation -1.96% -1.68% -1.28% -0.95% -0.87% -1.35% -0.72% -0.59% -0.49% -0.40% -0.33% -0.27% -0.23% -0.19% -0.15% -0.13%Accumulated other comprehensive income (loss) -8.25% -13.22% -8.83% 0.64% -2.00% -6.33%Total shareholders equity 41.67% 39.10% 44.80% 50.12% 49.24% 44.98% 44.98% 44.98% 44.98% 44.98% 44.98% 44.98% 44.98% 44.98% 44.98% 44.98%TOTAL LIABILITIES AND SHAREHOLDERS EQUITY 100% 100% 100% 100% 100% 100.00% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

- 63 -

Appendix C: Forecasted Income Statement

3M Income Statement for the Year Ending Actual Income Statement ForecastsExpressed in Millions 2001/12/31 2002/12/31 2003/12/31 2004/12/31 2005/12/31 AVG. Forecast 2006/12/31 2007/12/31 2008/12/31 2009/12/31 2010/12/31 2011/12/31 2012/12/31 2013/12/31 2014/12/31 2015/12/31Net sales $16,054 $16,332 $18,232 $20,011 $21,167 $18,359 6.96 $22,640 $24,216 $25,901 $27,704 $29,632 $31,695 $33,901 $36,260 $38,784 $41,483COGS $8,749 $8,496 $9,285 $9,958 $10,381 $9,374 4.35 $10,936 $11,521 $12,138 $12,787 $13,471 $14,192 $14,951 $15,751 $16,594 $17,482 Gross Profit $7,305 $7,836 $8,947 $10,053 $10,786 $8,985 $11,704 $12,695 $13,764 $14,917 $16,161 $17,503 $18,949 $20,509 $22,190 $24,002Operating expenses:Selling, general and administrative expenses $4,036 $3,720 $4,039 $4,281 $4,535 $4,122 $4,624 $4,710 $4,791 $4,868 $4,940 $5,005 $5,063 $5,112 $5,152 $5,181Research and development $1,084 $1,070 $1,102 $1,194 $1,242 $1,138 $1,613 $2,015 $2,449 $2,917 $3,423 $3,967 $4,554 $5,184 $5,862 $6,590Other expense (income) ($88) $93 No TrendTotal operating expenses $5,032 $4,790 $5,234 $5,475 $5,777 $5,262 $6,238 $6,725 $7,240 $7,786 $8,363 $8,972 $9,616 $10,296 $11,014 $11,771Operating income $2,273 $3,046 $3,713 $4,578 $5,009 $3,724 $5,466 $5,970 $6,523 $7,131 $7,798 $8,530 $9,333 $10,213 $11,176 $12,231Interest expense and income $87 $41 $56 $23 $26 $47 No TrendIncome before provision for income taxes $2,186 $3,005 $3,657 $4,555 $4,983 $3,677 $5,466 $5,970 $6,523 $7,131 $7,798 $8,530 $9,333 $10,213 $11,176 $12,231Provision for income taxes $702 $966 $1,202 $1,503 $1,694 $1,213 $1,758 $1,832 $1,914 $2,005 $2,107 $2,220 $2,346 $2,485 $2,639 $2,810Minority interest $54 $65 $52 $62 $55 $58 Avg. $58 $58 $58 $58 $58 $58 $58 $58 $58 $58Cumulative effect of accounting change ($35) No TrendNet income $1,430 $1,974 $2,403 $2,990 $3,199 $2,399 $3,650 $4,080 $4,552 $5,068 $5,633 $6,252 $6,929 $7,669 $8,479 $9,363

- 64 -

Appendix D: Common Size Forecasted Income Statement

3M: Income Statement for the Year Ending Actual Income Statement ForecastsExpressed in Millions 2001 2002 2003 2004 2005 AVG. 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015Net sales 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%COGS 54.50% 52.02% 50.93% 49.76% 49.04% 51.25% 62.50% 48.31% 47.58% 46.86% 46.16% 45.46% 44.78% 44.10% 43.44% 42.79% Gross Profit 45.50% 47.98% 49.07% 50.24% 50.96% 48.94% 51.69% 52.42% 53.14% 53.84% 54.54% 55.22% 55.90% 56.56% 57.21% 57.86%Operating expenses:Selling, general and administrative expenses 25.14% 22.78% 22.15% 21.39% 21.42% 22.58% 20.43% 19.45% 18.50% 17.57% 16.67% 15.79% 14.93% 14.10% 13.28% 12.49%Research and development 6.75% 6.55% 6.04% 5.97% 5.87% 6.24% 7.13% 8.32% 9.45% 10.53% 11.55% 12.52% 13.43% 14.30% 15.11% 15.89%Other expense (income) -0.55% 0.51%Total operating expenses 31.34% 29.33% 28.71% 27.36% 27.29% 28.81% 27.55% 27.77% 27.95% 28.10% 28.22% 28.31% 28.37% 28.40% 28.40% 28.37%Operating income 14.16% 18.65% 20.37% 22.88% 23.66% 19.94% 24.14% 24.65% 25.19% 25.74% 26.32% 26.91% 27.53% 28.16% 28.82% 29.48%Interest expense and income 0.54% 0.25% 0.31% 0.11% 0.12% 0.27%Income before provision for income taxes 13.62% 18.40% 20.06% 22.76% 23.54% 19.68% 24.14% 24.65% 25.19% 25.74% 26.32% 26.91% 27.53% 28.16% 28.82% 29.48%Provision for income taxes 4.37% 5.91% 6.59% 7.51% 8.00% 6.48% 7.77% 7.56% 7.39% 7.24% 7.11% 7.01% 6.92% 6.85% 6.81% 6.77%Minority interest 0.34% 0.40% 0.29% 0.31% 0.26% 0.32% 0.26% 0.24% 0.22% 0.21% 0.20% 0.18% 0.17% 0.16% 0.15% 0.14%Cumulative effect of accounting change -0.17% -0.03%Net income 8.91% 12.09% 13.18% 14.94% 15.11% 12.85% 16.12% 16.85% 17.57% 18.29% 19.01% 19.73% 20.44% 21.15% 21.86% 22.57%

- 65 -

Appendix E: Forecasted Cash Flows Statement

3M Cash Flows Actual Cash Flows ForecastsExpressed in Millions 2001/12/31 2002/12/31 2003/12/31 2004/12/31 2005/12/31 AVG. Forecast 2006/12/31 2007/12/31 2008/12/31 2009/12/31 2010/12/31 2011/12/31 2012/12/31 2013/12/31 2014/12/31 2015/12/31CASH FLOWS FROM OPERATING ACTIVITIES:Net income $1,430 $1,974 $2,403 $2,990 $3,199 $2,399 I/S $3,650 $4,080 $4,552 $5,068 $5,633 $6,252 $6,929 $7,669 $8,479 $9,363Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization $1,089 $954 $964 $999 $986 $998 Avg. $998 $998 $998 $998 $998 $998 $998 $998 $998 $998Company pension and post retiement contributions ($157) ($1,086) ($943) ($759) ($788) ($747) Avg. ($747) ($747) ($747) ($747) ($747) ($747) ($747) ($747) ($747) ($747)Company pension and postretirment expense $256 $435 $437 $376 Avg. & Growth $387 $399 $411 $423 $436 $449 $462 $476 $491 $505Deferred income tax provision $1 $579 $115 $313 $147 $231 No TrendChanges in assets and liabilities Accounts receivable $345 $145 $38 $56 ($184) $80 No Trend Inventories $194 $279 $281 $7 ($294) $93 $5 $5 $5 $5 $5 $5 $5 $5 $5 $5Accounts payable and other current liabilities ($62) ($33) $62 $35 $113 $23 AVG $23 $23 $23 $23 $23 $23 $23 $23 $23 $23Other current assets ($97) $58 ($20) No TrendOther assets- net of amortization $109 ($54) $28 No TrendAccrued income tax $211 ($11) $424 $83 $270 $195 7.55 $290 $327 $369 $416 $469 $529 $597 $673 $759 $856Other liabilities $8 $113 $24 No TrendProduct and other insurance receivables and claims ($35) $12 $122 $33 Avg. Change $153 $184 $215 $246 $277 $308 $339 $370 $401 $432Other-net $7 $74 $208 $111 $250 $130 No TrendNet cash provided by operating activities $3,078 $2,992 $3,773 $4,282 $4,258 $3,677 $4,760 $5,270 $5,826 $6,433 $7,095 $7,818 $8,606 $9,468 $10,408 $11,435

CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property, plant, and equipment (PP&E) ($980) ($763) ($677) ($937) ($943) ($860) 12.76 ($1,063) ($1,199) ($1,352) ($1,525) ($1,719) ($1,938) ($2,186) ($2,465) ($2,779) ($3,134)Proceeds from sale of property and equipment $113 $83 $129 $69 $41 $87 No TrendAcquisitions, net of cash acquired ($218) ($1,258) ($439) ($73) ($1,293) ($656) Avg. ($656) ($656) ($656) ($656) ($656) ($656) ($656) ($656) ($656) ($656)Purchase of investments ($12) ($7) ($16) ($10) ($1,627) ($334) Avg. ($334) ($334) ($334) ($334) ($334) ($334) ($334) ($334) ($334) ($334)Proceeds from sale of investments $47 $18 $34 $13 $1,581 $339 No TrendNet cash used in investing activities ($1,050) ($1,927) ($969) ($938) ($2,241) ($1,425) ($2,053) ($2,189) ($2,342) ($2,515) ($2,709) ($2,928) ($3,176) ($3,455) ($3,769) ($4,124)

CASH FLOWS FROM FINANCING ACTIVITIES:Change in short-term debt-net ($20) ($204) ($215) $399 ($258) ($60) 1% growth ($261) ($263) ($266) ($268) ($271) ($274) ($277) ($279) ($282) ($285)Repayment of debt (maturity greater than 90 days) ($1,564) ($497) ($719) ($868) ($656) ($861) No TrendProceeds from debt (maturity greater than 90 days) $1,693 $1,146 $494 $358 $429 $824 No TrendPurchase of treasury stock ($1,322) ($942) ($685) ($1,791) ($2,377) ($1,423) 11.00 ($2,638) ($2,929) ($3,251) ($3,608) ($4,005) ($4,446) ($4,935) ($5,478) ($6,080) ($6,749)Reissuance of treasury stock $462 $522 $555 $508 $545 $518 Avg. $518 $518 $518 $518 $518 $518 $518 $518 $518 $518Dividens paid to stockholders ($948) ($968) ($1,034) ($1,125) ($1,286) ($1,072) 7.88 ($1,387) ($1,497) ($1,615) ($1,742) ($1,879) ($2,027) ($2,187) ($2,359) ($2,545) ($2,746)Distributions to minority interests ($17) ($78) ($13) ($11) ($56) ($35) No TrendOther- net ($10) ($4) ($20) ($11) No TrendNet cash used in financing activities ($1,716) ($1,021) ($1,627) ($2,534) ($3,679) ($2,115) ($3,768) ($4,171) ($4,613) ($5,101) ($5,638) ($6,229) ($6,881) ($7,598) ($8,390) ($9,262)Effect of exchange rate changes on cash $2 ($42) $41 $111 ($23) $18 No TrendNet increase in cash and cash equivalents $314 $2 $1,218 $921 ($1,685) $154 No TrendCash and cash equivalents, beginning of period $302 $616 $618 $1,836 $2,757 $1,226 Avg. $1,226 $1,226 $1,226 $1,226 $1,226 $1,226 $1,226 $1,226 $1,226 $1,226Cash and cash equivalents, end of period $616 $618 $1,836 $2,757 $1,072 $1,380 8.26 $2,985 $3,231 $3,498 $3,787 $4,100 $4,439 $4,805 $5,202 $5,632 $6,097

- 66 -

Appendix F: Forecasted Ratios

Ratios Actual Ratio Forecasts

2001 2002 2003 2004 2005 AVG. 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015LIQUIDITY RATIOSCurrent Ratio 1.40 1.36 1.52 1.44 1.36 1.41 1.41 1.41 1.41 1.41 1.41 1.41 1.41 1.41 1.41 1.41Quick Asset Ratio 0.69 0.71 0.90 0.91 0.75 0.79 0.79 0.79 0.79 0.79 0.79 0.79 0.79 0.79 0.79 0.79

EFFICIENCY RATIOSAccounts Receivable Turnover 6.47 6.46 6.72 7.17 7.46 6.85 7.63 7.81 7.98 8.16 8.33 8.51 8.68 8.86 9.03 9.21Days' Receivables 56.43 56.48 54.33 50.93 48.94 53.42 47.82 46.74 45.72 44.74 43.80 42.90 42.03 41.20 40.41 39.64Inventory Turnover 4.18 4.40 5.11 5.25 4.80 4.75 4.86 4.92 4.98 5.04 5.10 5.16 5.22 5.28 5.34 5.40Days' Inventory 87.23 82.96 71.39 69.53 76.02 77.43 75.08 74.16 73.27 72.40 71.55 70.71 69.90 69.11 68.33 67.57Working Capital Turnover 8.98 10.19 6.91 7.55 11.28 8.98 4.18 4.18 4.18 4.18 4.18 4.18 4.18 4.18 4.18 4.18

PROFITABILITY RATIOSGross Profit Margin 45.50% 47.98% 49.07% 50.24% 50.96% 48.75% 51.69% 52.42% 53.14% 53.84% 54.54% 55.22% 55.90% 56.56% 57.21% 57.86%Operating Expense Ratio 31.34% 29.33% 28.71% 27.36% 27.29% 28.81% 27.55% 27.77% 27.95% 28.10% 28.22% 28.31% 28.37% 28.40% 28.40% 28.37%Net Profit Margin 8.91% 12.09% 13.18% 14.94% 15.11% 12.85% 16.12% 16.85% 17.57% 18.29% 19.01% 19.73% 20.44% 21.15% 21.86% 22.57%Asset Turnover 1.10 1.07 1.04 0.97 1.03 1.04 1.04 1.04 1.04 1.04 1.04 1.04 1.04 1.04 1.04 1.04Return on Assets 9.79% 12.88% 13.65% 14.44% 15.59% 13.27% 16.76% 17.52% 18.27% 19.02% 19.77% 20.51% 21.25% 21.99% 22.73% 23.47%Return on Equity 23.50% 32.94% 30.48% 28.81% 31.67% 29.48% 37.26% 38.95% 40.62% 42.28% 43.94% 45.59% 47.24% 48.89% 50.53% 52.17%

CAPITAL STRUCTURE ANALYSISDebt to Equity Ratio 139.99% 155.78% 123.21% 99.54% 103.10% 124.32% 122.30% 122.30% 122.30% 122.30% 122.30% 122.30% 122.30% 122.30% 122.30% 122.30%Times Interest Earned 25.51 72.71 65.38 196.35 189.19 109.83 No TrendDebt Service Margin 44.61% 41.34% 31.86% 48.90% 25.18% 37.96% 23.09% 21.37% 19.82% 18.40% 17.10% 15.90% 14.81% 13.80% 12.86% 12.00%Total Liabilities to Total Assets 58.33% 60.90% 55.20% 49.88% 50.76% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02% 55.02%

OTHER RATIOSAccounts Payable Turnover 21.32 17.28 16.77 17.13 16.85 17.87 112.39 112.39 112.39 112.39 112.39 112.39 112.39 112.39 112.39 112.39R&D to Net Income 75.80% 54.20% 45.86% 39.93% 38.82% 50.93% 44.20% 49.38% 53.80% 57.57% 60.76% 63.46% 65.72% 67.59% 69.14% 70.38%Goodwill to Total Assets 6.93% 12.38% 13.74% 12.82% 16.93% 12.56% 17.79% 18.56% 19.35% 20.18% 21.05% 21.95% 22.89% 23.88% 24.90% 25.97%

- 67 -

Appendix G: Discounted Free Cash Flows

3M (Amounts in millions of dollars except per share data)

1 2 3 4 5 6 7 8 92006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Cash Flow from Operations 3,650 4,080 4,552 5,068 5,633 6,252 6,929 7,669 8,479 9,363 Cash Provided (Used) by Investing Activities (2,189) (2,342) (2,515) (2,709) (2,928) (3,176) (3,455) (3,769) (4,124)

1,891 2,210 2,554 2,924 3,324 3,753 4,215 4,710 5,239 Free Cash Flow (to firm)Discount rate 0.0824 0.924 0.854 0.789 0.729 0.673 0.622 0.574 0.531 0.490

Present Value of Free Cash Flows 1747.3 1886.1 2013.6 2130.5 2237.2 2334.0 2421.4 2499.7 2569.2 Total Present Value of Annual Cash Flows 19,839 16.84% 15.56% 14.52% 13.66% 12.92% 12.29% 11.74% 11.25% Continuing (Terminal) Value (assume no growth) 58281.10 Present Value of Continuing (Terminal) Value 28,578 Value of the Firm (end of 2006) 48,417 Sensitivity Analysis Book Value of Debt and Preferred Stock 10,413 Growth 0 0.01 0.02 0.03 0.04 0.05 Value of Equity (end of 2006) 38,004 WACC 0.05 $96.62 $116.59 $149.87 216.44 $416.15 Estimated Value Per Share 49.04 0.06 $76.34 $88.56 $106.90 137.46 $198.59 $381.97

0.07 $61.94 $69.96 $81.20 98.05 $126.13 $182.31Growth Rate 0.00 0.0824 $49.04 $54.13 $60.85 $70.15 $83.82 $105.94

Value of Continuing Perpetuity 4802.36 0.09 $42.93 $46.89 $51.99 $58.78 $68.29 $82.560.1 $36.36 $39.28 $42.93 $47.62 $53.88 $62.64

0.11 $31.03 $33.23 $35.92 $39.28 $43.61 $49.380.12 $26.62 28.31 30.34 32.83 $35.93 $39.92


- 68 -

Appendix H: Discounted Valuation


1 2 3 4 5 6 7 8 92006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Actual Dividends Per Share (Forecasted) $1.93 $2.08 $2.25 $2.42 $2.62 $2.82 $3.04 $3.28 $3.54 Present Value Factor 0.917 0.840 0.770 0.706 0.647 0.593 0.544 0.498 0.457

Present Value of Future Dividends (Forecasted) $1.77 $1.75 $1.73 $1.71 $1.69 $1.67 $1.65 $1.64 $1.62

Total Present Value of Forecast Future Dividends $15.24 Sensitivity Analysis Continuing (Terminal) Value (assume no growth) $35.68 Present Value of Continuing (Terminal) Value $6.96 Growth 0 0.01 0.02 0.03 0.04 0.05

Ke 0.06 49.64 56.05 65.66 81.68 113.71 209.81 Estimated Value Per Share $22.19 0.07 42.02 46.22 52.11 60.94 75.66 105.10

0.08 36.33 39.23 43.09 48.51 56.63 70.17Ke 0.091 0.091 31.53 33.54 36.12 39.54 44.31 51.40

Growth Rate 0.00 0.10 28.41 29.94 31.85 34.31 37.59 42.18Value of Continuing Perpetuity 3.25 0.11 25.55 26.70 28.11 29.88 32.14 35.16

0.12 23.18 24.07 25.13 26.43 28.06 30.15


- 69 -

Appendix I: Residual Income Valuation


1 2 3 4 5 6 7 8 92006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Beginning BE (per share) 12.64 16.27 20.37 25.04 30.35 36.40 43.29 51.12 60.02

Earnings Per Share 5.56 6.34 7.20 8.14 9.18 10.32 11.56 12.93 14.42

Dividends per share 1.93 2.23 2.53 2.83 3.13 3.43 3.73 4.03 4.33 Ending BE (per share) 12.64 16.27 20.37 25.04 30.35 36.40 43.29 51.12 60.02 70.11

Ke 0.091 "Normal" Income 1.15 1.48 1.85 2.28 2.76 3.31 3.94 4.65 5.46 Residual Income (RI) 4.41 4.86 5.34 5.86 6.42 7.00 7.62 8.28 8.96

Discount Factor 0.917 0.840 0.770 0.706 0.647 0.593 0.544 0.498 0.457 Present Value of RI 4.04 4.08 4.12 4.14 4.15 4.15 4.14 4.12 4.09

ValuePercent Sensitivity Analysis BV Equity (per share) 2006 12.64 13.90% Total PV of RI (end 2006) 37.04 40.75% Growth 0 0.01 0.02 0.03 0.04 0.05 Continuation (Terminal) Value 90.28 Ke 0.06 158.33 177.71 206.79 225.25 352.17 642.93 PV of Terminal Value (end 2006) 41.22 45.35% 0.07 129.01 141.01 157.81 183.01 225.00 309.00 Estimated Value (2006) $90.91 100.00% 0.08 107.45 115.22 125.60 140.12 161.90 198.20

89.60 0.091 89.60 94.61 101.04 109.58 121.46 127.890.1 78.17 81.75 86.23 91.98 99.65 110.40

0.11 67.90 70.40 74.75 77.29 82.21 88.76 Actual Price per share $78.84 0.12 59.54 61.31 63.44 66.04 69.30 73.48

Growth 0.00Value of Continuing Perpetuity 8.22 Overvalue <65

Undervalue >96Fair Value 65-96

- 70 -

Appendix J: Long Run ROE Perpetuity


1 2 3 4 5 6 7 8 92006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Beginning BE (per share) 12.64 16.27 20.37 25.04 30.35 36.40 43.29 51.12 60.02 Earnings Per Share 5.56 6.34 7.20 8.14 9.18 10.32 11.56 12.93 14.42 Dividends per share 1.93 2.23 2.53 2.83 3.13 3.43 3.73 4.03 4.33

Ending BE (per share) 12.64 16.27 20.37 25.04 30.35 36.40 43.29 51.12 60.02 70.11 Ke 0.091

ROE 43.97% 38.97% 35.33% 32.52% 30.24% 28.34% 26.71% 25.29% 24.03% Growth inBVE 28.69% 25.25% 22.91% 21.21% 19.93% 18.92% 18.09% 17.41% 16.82%

Actual Price per share $78.84

Average ROE 35.00% Average Growth in BVE 0.05%

LRResInc Perp Value 48.81

Estimated Value (2006) 52.49

- 71 -

Sensitivity Analysis Sensitivity Analysis

Growth 0 0.01 0.02 0.03 0.04 0.05 Growth 0 0.01 0.02 0.03 0.04 0.050.05 $83.49 $83.63 $83.77 $83.91 $84.06 $84.20 0.25 $37.34 $37.37 $37.39 $37.42 $37.44 $37.47

0.06 $70.13 $70.22 $70.32 $70.41 $70.51 $70.60 0.27 $40.33 $40.36 $40.39 $40.41 $40.44 $40.47

0.07 $60.58 $60.65 $60.72 $60.78 $60.85 $60.92 0.29 $43.31 $43.35 $43.38 $43.41 $43.44 $43.48

0.08 $53.42 $53.47 $53.52 $53.57 $53.62 $53.67 ROE 0.31 $46.30 $46.34 $46.37 $46.41 $46.45 $46.48

Ke 0.091 $47.36 $47.40 $47.44 $47.47 $47.51 $47.55 0.3171 $47.36 $47.40 $47.44 $47.47 $47.51 $47.55

0.1 $43.39 $43.42 $43.45 $43.48 $43.51 $43.54 0.32 $47.79 $47.83 $47.87 $47.91 $47.95 $47.98

0.11 $39.75 $39.77 $39.80 $39.82 $39.84 $39.87 0.33 $49.29 $49.33 $49.37 $49.41 $49.45 $49.49

0.12 $36.71 $36.73 $36.75 $36.77 $36.79 $36.80 0.35 52.28 $52.32 $52.36 $52.40 $52.45 $52.49


Ke 0.091 0.13 0.15 0.17 0.19 0.2 0.22 0.23 0.24 0.25Overvalue <65 0.25 -$4.53 -$6.93 -$9.37 -$14.23 -$28.70 -$57.11 $60.79 $30.22 20.2 $15.22

Undervalue >96 0.27 -$6.81 -$10.42 -$14.09 -$21.39 -$43.13 -$85.84 $91.37 $45.43 $30.37 $22.88

Fair Value 65-96 0.29 -$9.09 -$13.91 -$18.80 -$28.55 -57.57 -$114.56 $121.95 $60.64 $40.53 $30.54

0.3 -$10.23 -$15.65 -$21.16 -$32.13 -$64.79 -$128.93 $137.24 $68.24 $45.61 $34.37

ROE 0.31 -$11.37 -$17.40 -$23.52 -$35.71 -$72.00 -$143.29 $152.53 $75.84 $50.69 $38.20

0.3171 -$12.18 -$18.64 -$25.19 -$38.25 -$77.13 -$153.49 $163.39 $81.24 $54.30 $40.92

0.32 -$12.51 -$19.14 -$25.87 -$39.29 -$79.22 -$157.66 $167.82 $83.44 $55.78 $42.03

0.33 -$13.65 -$20.89 -$28.23 -$42.87 -$86.44 -$172.02 $183.11 $91.05 $60.86 $45.86

0.34 -$14.79 -$22.63 -$30.59 -$46.45 -$93.66 -$186.39 $198.40 $98.65 $65.94 $49.69

- 72 -

Appendix K: Abnormal Earnings Growth


1 2 3 4 5 6 7 82006 2007 2008 2009 2010 2011 2012 2013 2014 2015

EPS $5.26 $5.87 $6.54 $7.27 $8.07 $8.94 $9.90 $10.94 $12.08 DPS $1.93 $2.08 $2.25 $2.42 $2.62 $2.82 $3.04 $3.28 $3.54 DPS invested $0.18 $0.19 $0.20 $0.22 $0.24 $0.26 $0.28 $0.30 Cum-Dividend Earnings $6.05 $6.73 $7.47 $8.29 $9.18 $10.15 $11.22 $12.38 Normal Earnings $5.74 $6.41 $7.13 $7.93 $8.80 $9.75 $10.80 $11.94 Abnormal Earning Growth (AEG) $0.30 $0.32 $0.34 $0.36 $0.38 $0.40 $0.42 $0.44

PV Factor 0.917 0.840 0.770 0.706 0.647 0.593 0.544 0.498 PV of AEG $0.28 $0.27 $0.26 $0.25 $0.24 $0.24 $0.23 $0.22

Core EPS 5.26 Sensitivity Analysis Total PV of AEG 1.99 Continuing (Terminal) Value 5.33 Growth 0 0.01 0.02 0.03 0.04 0.05 PV of Terminal Value 2.65 Ke 0.06 271.46 297.39 Total PV of AEG 4.65 0.07 193.73 206.80 225.10 252.54 298.29 389.78 Total Average EPS Perp (t+1) 9.91 0.08 144.52 151.47 160.75 173.73 193.20 225.66 Capitalization Rate (perpetuity) 0.091 0.091 108.93 112.53 117.14 123.27 131.80 144.50

0.1 88.60 90.73 93.38 96.79 101.34 107.71 Estimated Value Per Share $108.93 0.11 71.98 73.14 74.57 76.36 78.66 81.72

0.12 59.61 60.23 60.97 61.88 63.01 64.47Ke 0.091 0.13 50.83 51.25 51.76 52.40

Growth Rate 0Value of Continuing Perpetuity 0.48 Overvalue <65

Undervalue >96Actual Price per share $78.84 Fair Value 65-96

- 73 -

Appendix L: Z-Score


2001 2002 2003 2004 2005Working Capital 1,787.00 1,602.00 2,638.00 2,649.00 1,877.00Retained Earnings 11,914.00 12,748.00 14,010.00 15,649.00 17,358.00Total Assets 14,606.00 15,329.00 17,600.00 20,708.00 20,513.00Earnings before Interest and Taxes 2,219.00 2,981.00 3,661.00 4,516.00 4,919.00Market Value of Equity 78.84 78.84 78.84 78.84 78.84Sales 16,054.00 16,332.00 18,232.00 20,011.00 21,167.00Book Value of Liabilities 8,520.00 9,336.00 9,715.00 10,330.00 10,413.00

Z-Score 2.89 3.00 3.02 2.90 3.12

- 74 -

Appendix M: Estimated Beta

Date Close Dividends 3M Returns Close S&P Returns Market Premiums Risk Free Annual Monthly Risk Free

2-Oct-06 78.84 78.84 0.05939264 1377.94 0.031508029 0.027599695 1-Oct-06 4.69 0.0039083331-Sep-06 74.42 74.42 0.03131929 1335.85 0.024566274 0.020674608 1-Sep-06 4.67 0.0038916671-Aug-06 71.7 0.46 72.16 0.025 1303.82 0.021274263 0.017257596 1-Aug-06 4.82 0.0040166673-Jul-06 70.4 70.4 -0.12838925 1276.66 0.005085813 0.000885813 1-Jul-06 5.04 0.0042

1-Jun-06 80.77 80.77 -0.03982406 1270.2 8.6608E-05 -0.004138392 1-Jun-06 5.07 0.0042251-May-06 83.66 0.46 84.12 -0.01533419 1270.09 -0.0309169 -0.035083568 1-May-06 5.00 0.0041666673-Apr-06 85.43 85.43 0.12868279 1310.61 0.01215566 0.008072327 1-Apr-06 4.90 0.0040833331-Mar-06 75.69 75.69 0.0221472 1294.87 0.011095841 0.007162508 1-Mar-06 4.72 0.0039333331-Feb-06 73.59 0.46 74.05 0.01786942 1280.66 0.000453097 -0.003355237 1-Feb-06 4.57 0.0038083333-Jan-06 72.75 72.75 -0.06129032 1280.08 0.025466839 0.021841839 1-Jan-06 4.35 0.0036251-Dec-05 77.5 77.5 -0.01774398 1248.29 -0.0009524 -0.00461073 1-Dec-05 4.39 0.0036583331-Nov-05 78.48 0.42 78.9 0.03843117 1249.48 0.035186121 0.031477788 1-Nov-05 4.45 0.0037083333-Oct-05 75.98 75.98 0.03571429 1207.01 -0.01774074 -0.021349074 1-Oct-05 4.33 0.0036083331-Sep-05 73.36 73.36 0.02501048 1228.81 0.00694894 0.003607273 1-Sep-05 4.01 0.0033416671-Aug-05 71.15 0.42 71.57 -0.04573333 1220.33 -0.01122203 -0.014655359 1-Aug-05 4.12 0.0034333331-Jul-05 75 75 0.0373444 1234.18 0.035968204 0.032651537 1-Jul-05 3.98 0.003316667

1-Jun-05 72.3 72.3 -0.06189179 1191.33 -0.00014268 -0.003284344 1-Jun-05 3.77 0.0031416672-May-05 76.65 0.42 77.07 0.00784621 1191.5 0.029952025 0.026743692 1-May-05 3.85 0.0032083331-Apr-05 76.47 76.47 -0.10759715 1156.85 -0.02010859 -0.023441923 1-Apr-05 4.00 0.0033333331-Mar-05 85.69 85.69 0.01576577 1180.59 -0.01911765 -0.022592647 1-Mar-05 4.17 0.0034751-Feb-05 83.94 0.42 84.36 0 1203.6 0.018903384 0.015761717 1-Feb-05 3.77 0.0031416673-Jan-05 84.36 84.36 0.02790301 1181.27 -0.02529045 -0.028382115 1-Jan-05 3.71 0.0030916671-Dec-04 82.07 82.07 0.02651657 1211.92 0.032458128 0.029458128 1-Dec-04 3.60 0.0031-Nov-04 79.59 0.36 79.95 0.03068196 1173.82 0.038594939 0.035653272 1-Nov-04 3.53 0.0029416671-Oct-04 77.57 77.57 -0.03001125 1130.2 0.014014248 0.011222581 1-Oct-04 3.35 0.0027916671-Sep-04 79.97 79.97 -0.03324468 1114.58 0.009363906 0.006563906 1-Sep-04 3.36 0.00282-Aug-04 82.36 0.36 82.72 0.00437105 1104.24 0.002287333 -0.000604334 1-Aug-04 3.47 0.0028916671-Jul-04 82.36 82.36 -0.08499056 1101.72 -0.03429052 -0.037365523 1-Jul-04 3.69 0.003075

1-Jun-04 90.01 90.01 0.05993877 1140.84 0.017989078 0.014714078 1-Jun-04 3.93 0.003275

- 75 -

3-May-04 84.56 0.36 84.92 -0.01803885 1120.68 0.012083446 0.008875113 1-May-04 3.85 0.0032083331-Apr-04 86.48 86.48 0.05630878 1107.3 -0.01679083 -0.019615829 1-Apr-04 3.39 0.0028251-Mar-04 81.87 81.87 0.04452666 1126.21 -0.01635894 -0.018683936 1-Mar-04 2.79 0.0023252-Feb-04 78.02 0.36 78.38 -0.00897711 1144.94 0.01220903 0.009650697 1-Feb-04 3.07 0.0025583332-Jan-04 79.09 79.09 -0.0698577 1131.13 0.017276423 0.014676423 1-Jan-04 3.12 0.00261-Dec-03 85.03 85.03 0.07131158 1111.92 0.050765451 0.048040451 1-Dec-03 3.27 0.0027253-Nov-03 79.04 0.33 79.37 0.006339546 1058.2 0.007128513 0.004386846 1-Nov-03 3.29 0.0027416671-Oct-03 78.87 78.87 0.14188504 1050.71 0.054961495 0.052303161 1-Oct-03 3.19 0.0026583332-Sep-03 69.07 2:1 stock split 69.07 -0.03263305 995.97 -0.01194433 -0.014594326 1-Sep-03 3.18 0.002651-Aug-03 71.235 0.165 71.4 0.01854494 1008.01 0.017873191 0.015064858 1-Aug-03 3.37 0.0028083331-Jul-03 70.1 70.1 0.08699023 990.31 0.016223704 0.013832038 1-Jul-03 2.87 0.002391667

2-Jun-03 64.49 64.49 0.01719243 974.5 0.011322243 0.009430576 1-Jun-03 2.27 0.0018916671-May-03 63.235 0.165 63.4 0.00602983 963.59 0.050898661 0.048798661 1-May-03 2.52 0.00211-Apr-03 63.02 63.02 -0.03068523 916.92 0.081044118 0.078602451 1-Apr-03 2.93 0.0024416673-Mar-03 65.015 65.015 0.0344471 848.18 0.008357606 0.006040939 1-Mar-03 2.78 0.0023166673-Feb-03 62.685 0.165 62.85 0.00923324 841.15 -0.01700362 -0.019420289 1-Feb-03 2.90 0.0024166672-Jan-03 62.275 62.275 0.01013788 855.7 -0.0274147 -0.029956365 1-Jan-03 3.05 0.0025416672-Dec-02 61.65 61.65 -0.05270436 879.82 -0.06033258 -0.062857582 1-Dec-02 3.03 0.0025251-Nov-02 64.925 0.155 65.08 0.025366315 936.31 0.057069635 0.054527968 1-Nov-02 3.05 0.0025416671-Oct-02 63.47 63.47 0.15431481 885.76 0.086448827 0.083990494 1-Oct-02 2.95 0.0024583333-Sep-02 54.985 54.985 -0.1220661 815.28 -0.11002434 -0.112474343 1-Sep-02 2.94 0.002451-Aug-02 62.475 0.155 62.63 -0.00452992 916.07 0.00488142 0.002139753 1-Aug-02 3.29 0.0027416671-Jul-02 62.915 62.915 0.02300813 911.62 -0.07900426 -0.082179263 1-Jul-02 3.81 0.003175

3-Jun-02 61.5 61.5 -0.021791 989.82 -0.07245535 -0.075947015 1-Jun-02 4.19 0.0034916671-May-02 62.715 0.155 62.87 -0.00047695 1067.14 -0.00908145 -0.012823121 1-May-02 4.49 0.0037416671-Apr-02 62.9 62.9 0.09381793 1076.92 -0.06141765 -0.065292652 1-Apr-02 4.65 0.0038751-Mar-02 57.505 57.505 -0.02731732 1147.39 0.036738861 0.032788861 1-Mar-02 4.74 0.003951-Feb-02 58.965 0.155 59.12 0.06522523 1106.73 -0.02076624 -0.024349569 1-Feb-02 4.30 0.0035833332-Jan-02 55.5 55.5 -0.06099315 1130.2 -0.01557383 -0.019190494 1-Jan-02 4.34 0.0036166673-Dec-01 59.105 59.105 0.02898677 1148.08 0.007573829 0.003915496 1-Dec-01 4.39 0.0036583331-Nov-01 57.29 0.15 57.44 0.10059398 1139.45 0.07517598 0.071867647 1-Nov-01 3.97 0.0033083331-Oct-01 52.19 52.19 1059.78 -0.003258333 1-Oct-01 3.91 0.003258333

- 76 -

Appendix N: Regression Check

5 Year Constant Maturity RateMonths Beta R^2 Ke

60 0.626389 0.145028 0.09074748 0.666731 0.097293 0.09357136 0.820566 0.08069 0.1043424 0.859158 0.070697 0.107041

Regression StatisticsMultiple R 0.333318252R Square 0.111101057Adjusted R Square 0.07069656Standard Error 0.053095181Observations 24

ANOVAdf SS MS F Significance F

Regression 1 0.007751731 0.007752 2.74972 0.11146313Residual 22 0.062020162 0.002819Total 23 0.069771893

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.002063349 0.011133137 -0.185334 0.854665 -0.02515206 0.021025 -0.02515206 0.021025363Market Premiums 0.859158106 0.518118203 1.658228 0.111463 -0.21535328 1.933669 -0.21535328 1.933669488

- 77 -




Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept -0.002267816 0.00865577 -0.262 0.794902 -0.01985846 0.015323 -0.01985846 0.015322826Market Premiums 0.820566262 0.406638305 2.017927 0.051546 -0.0058222 1.646955 -0.0058222 1.64695472




Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.001574102 0.007471539 0.21068 0.834068 -0.01346533 0.016614 -0.01346533 0.01661353Market Premiums 0.666731394 0.270715231 2.462851 0.017587 0.121809906 1.211653 0.121809906 1.211652881

- 78 -

- 79 -

Regression Statistics

Multiple R 0.399398103R Square 0.159518844Adjusted R Square 0.14502779Standard Error 0.053472628Observations 60



Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007344087 0.006912605 1.06242 0.292449 -0.006493 0.021181 -0.006493 0.02118117Market Premiums 0.626389014 0.188793974 3.317844 0.00157 0.248476818 1.004301 0.248476818 1.00430121

- 80 -

References

1.) Edgarscan

http://edgarscan.pwcglobal.com/servlets/edgarscan

• financial statements

• notes to financial statements

• additional footnotes to financial statements

2.) 3M Company website

http://3m.com

• Financial statements

• Company information

3.) Johnson & Johnson company website

http://www.jnj.com/home.htm

• Information about competitor

4.) Avery Dennison company website

http://www.avery.com/

5.) valueline.com

http://www.valueline.com/

• numbers used for the method of comparables

6.) yahoofinance.com

http://finance.yahoo.com/

• historical prices

• competitors

7.) St. Louis Federal Reserve website

http://research.stlouisfed.org/fred2/categories/22

• Interest rates used for the CAPM value model

8.) Business Analysis & Valuation: Using Financial Statements 3rd Edition

Palepu, Healy, Bernard. 2004

• Information about financial ratios and valuation models

http://edgarscan.pwcglobal.com/servlets/edgarscan

http://3m.com/

http://www.jnj.com/home.htm

http://www.avery.com/

http://www.valueline.com/

http://finance.yahoo.com/

http://research.stlouisfed.org/fred2/categories/22

3m equity valuation - texas tech...

Documents