Question

Question text

Analysis and Interpretation of Profitability

Balance sheets and income statements for 3M Company follow.

Consolidated Statements of Income
Years ended December 31 ($ millions)	2009	2008	2007
Net sales	$23,123	$25,269	$24,462
Operating expenses
Cost of sales	12,109	13,379	12,735
Selling, general and administrative expenses	4,907	5,245	5,015
Research, development and related expenses	1,293	1,404	1,368
Loss/(gain) from sale of business	--	23	(849)
Total operating expenses	18,309	20,051	18,269
Operating income	4,814	5,218	6,193
Interest expenses and income
Interest expense	219	215	210
Interest income	(37)	(105)	(132)
Total interest expense	182	110	78
Income before income taxes	4,632	5,108	6,115
Provision for income taxes	1,388	1,588	1,964
Net income including noncontrolling interest	3,244	3,520	4,151
Less: Net income attributable to noncontrolling interest	51	60	55
Net income	$ 3,193	$ 3,460	$ 4,096

Consolidated Balance Sheets
($ millions)	2009	2008
Assets
Current Assets
Cash and cash equivalents	$ 3,040	$ 1,849
Marketable securities-current	744	373
Accounts receivable-net	3,250	3,195
Inventories
Finished goods	1,255	1,505
Work in process	815	851
Raw materials and supplies	569	657
Total inventories	2,639	3,013
Other current assets	1,122	1,168
Total current assets	10,795	9,598
Marketable securities-noncurrent	825	352
Investments	103	111
Property, plant and equipment	19,440	18,812
Less: Accumulated depreciation	(12,440)	(11,926)
Property, plant and equipment-net	7,000	6,886
Goodwill	5,832	5,753
Intangible assets-net	1,342	1,398
Prepaid pension benefits	78	36
Other assets	1,275	1,659
Total assets	$ 27,250	$ 25,793
Liabilities
Current liabilities
Short-term borrowings and current portion of long-term debt	$ 613	$ 1,552
Accounts payable	1,453	1,301
Accrued payroll	680	644
Accrued income taxes	252	350
Other current liabilities	1,899	1,992
Total current liabilities	4,897	5,839
Long-term debt	5,097	5,166
Pension and postretirement benefits	2,227	2,847
Other liabilities	1,727	1,637
Total liabilities	13,948	15,489
Equity
3M Company shareholders' equity: Common stock, par value $.01 per share;	9	9
Additional paid-in capital	3,153	3,006
Retained earnings	23,753	22,227
Treasury stock	(10,397)	(11,676)
Accumulated other comprehensive income (loss)	(3,754)	(3,686)
Total 3M Company shareholders' equity	12,764	9,880
Noncontrolling interest	538	424
Total equity	13,302	10,304
Total liabilities and equity	$ 27,250	$ 25,793

(e) Compute return on equity (ROE) for 2009. (Round your answers to two decimal places. Do not round until your final answer.)
2009 ROE =Answer%

(f) What is the nonoperating return component of ROE for 2009? (Round your answers to two decimal places.)
Hint: Use your prior rounded answers to compute this answer.
2009 nonoperating return =Answer%

(g) Which of the following statements reflects the best inference we can draw from the difference between 3M's ROE and RNOA?

ROE > RNOA implies that 3M has taken on too much financial leverage.

ROE > RNOA implies that 3M is able to borrow money to fund operating assets that yield a return greater than its cost of debt.

ROE > RNOA implies that 3M's equity has grown faster than its NOA.

ROE > RNOA implies that 3M has increased its financial leverage during the period.

Answer 1

E

ROE = Net Income / Average share holders Equity = 3193 / 11322 = 0.28 0r 28%

Average share holders Equity = Opening + Closing / 2

F

Non Operating Return = ROE - RNOA (Return on Net Operating Assets)

RNOA = NOPAT / Average Net Operating Asset = 3791 / 13976 = 0,27 or 27%

Average = Year 2008 + Year 2009 /2

Net Operating Assets = (Total Assets - Cash and Cash Equivalants - Marketable Security Current - Marketable Securties (Non Current) - Investement) - (Total Liabilities -  Short Term borrowings - Long term Debt)

NOPAT = Operating Profit - Tax on Operating Profit

Operating Profit = 5218

Tax on Operating Profit = Tax Expense + (Non Operating Expense Before Tax x Tax Rate) = 1388 + (110 x 35.9%)

= 1427

NOPAT = 5218 - 1427 = 3791

Non Operating Return = ROE - RNOA (Return on Net Operating Assets) = 28% - 27% = 1%

G

The answer is Option B

ROE > RNOA implies that 3M is able to borrow money to fund operating assets that yield a return greater than its cost of debt.