In the case a budget constraint is discussed. What is this constraint? Do you think it is important or should be reviewed?
Stryker Corporation: Capital Budgeting At the end of January 2007 Stryker Corporation, headquartered in Kalamazoo, Michigan, released operating and financial data for the fourth quarter of 2006, completing the picture of 2006 as a whole. The company's performance was strong; indeed, it was the latest in a string of strong performances going back many quarters. Sales of $5.4 billion for all of 2006 reflected an increase of 11.0%. EBIT grew by 15.6% to $1.1 billion. Net income was $778 million compared to $644 million in 2005, reflecting growth of 20.8%. It was Stryker's seventh straight year of double-digit growth in net income. Exhibit 1 presents summary operating and financial data for Stryker for the ten-year period 1997-2006. Exhibit 2 presents financial statements for the years 2005 and 2006. The performance of Stryker's stock mirrored its strong operating results. Earnings per share grew 20% from 2005 to 2006 . Even more impressive, the compound average growth in earnings per share over the preceding 30 years exceeded 20% per year. Not surprisingly, the company's stock price surged during this period. At the end of January 2007 Stryker's shares closed above $60 per share, posting a gain for the year of more than 24%. Gains recorded by the stock over the preceding ten years were similar. A $10,000 investment in Stryker stock in January 1997 was worth almost $90,000 in January 2007, a compounded return of nearly 25% per year, not including dividends. At current prices, the company's market capitalization exceeded $25 billion. Exhibit 3 shows Stryker's stock price performance during 1997-2006, adjusted for two 2-for-1 stock splits. At December 31, 2006 Stryker's balance sheet showed long-term debt of $14.8 million against total assets of $5.9 billion, of which $1.4 billion was cash and marketable securities. These figures reflected a striking long-term trend of declining leverage. Nearly ten years previously, in 1998, Stryker had doubled its size by acquiring Howmedica, a major producer of orthopaedic implants, from Pfizer, Inc. for $1.65 billion. By comparison, at the end of the prior year, Stryker's total assets had been less than $1.0 billion and its long-term debt less than $80 million. Stryker borrowed heavily to finance the acquisition of Howmedica and consequently its debt ballooned to $1.5 billion in 1998 . Net income fell in 1998 and again in 1999 before turning around in 2000. Since then earnings had resumed their steady 20% per year growth rate, and Stryker's debt was steadily reduced until it reached $26 million at the end of 2003. In the same year, the company's cash balance began growing rapidly, as shown in Exhibit 1. Given its track record, one of the toughest challenges facing Stryker in the decade ahead was how to keep it up. Sustaining the performance would require continuous investment in both new and 4 The Approval Process The approval process for large CERs had been modified in recent years to increase the spending authority thresholds at the Division and Group levels, institute more formal, standardized procedures, and require more rigorous analysis and documentation. The standard CER forms were also redesigned and came into usage along with the modified procedures in 2005. Partly as a result of the changes, the number of CERs requiring centralized approval fell from about 300 per year to about 30 per year. As part of the change, a Capital Committee was constituted and formally charged with reviewing and approving large CERs. Members of the Capital Committee included Stryker's CEO, CFO, Treasurer, Controller, General Counsel, VPs for Tax and Business Development, and the Director of IT. To receive spending authorization, a large project had to be approved by both the CEO and a majority of the other Capital Committee members. Each CER had a desi grated sponsor who served as liaison between the proposing division and the Capital Committee. Operational CERs were sponsored by the Controller. M\&A CERs were sponsored by the VP for Business Development. CERs for IT systems were sponsored by the Director of IT. The sponsor had several tasks to perform. The first part of the job was to assist the division in preparation of the CER and supporting documentation to ensure that it met Stryker standards for quality and completeness. Second, the sponsor coordinated the submission of the completed CER to ensure that Committee members all received complete information. Third, the sponsor served as an interface between Committee members and the division regarding requests for additional information and condi tions to be met for approval. Internal guidelines specified a timetable for submission, review, and disposition of CERs. These were intended to ensure that adequate time was allowed to review spending requests and to minimize the need for "emergency" approvals. In general, the guidelines provided for a minimum of two weeks between the time a division notified the appropriate sponsor of it intent to submit a CER and the formal consideration by the Capital Committee of the CER. About a week was devoted to a review process between the division and the sponsor, and another week set aside for review of the submission by individual Committee members, who could request additional information. The System in Practice: 2007 In early 2007 participants in the new process were still getting used to it. Some of the goals for the revised system were being met: more data, more depth, more analyses, more standardization and rigor. But there were complaints as well. The stipulated timetable for CER submission and review was not always met. Committee members complained about CERs not being submitted on time. Divisions complained about the Committee not being available as such when needed. Indeed, the Committee did not hold regular meetings as a group, but operated more as a "virtual" committee with members contacting one another as needed. The requirements for standardization and extensive documentation struck some managers as unnecessarily bureaucratic for proposals that were "no-brainers" and clearly assured of approval. Indeed, "The vast majority gets approved," controller Jim Praeger observed, "but recently a few CERs have not been approved." Finally, the heavy corporate involvement in the process clashed somewhat with Stryker's decentralized organization and entrepreneurial culture. One division executive said simply, "It's painful." This document is asthorized lor use orly by John Aichards (jphn.ichands sas Agmal com). Capying or posting is an intingenert of copyright. Please cortact customenevicelianardousiness org or 8009880895 lor addions copies. Stryker Corporation: Capital Budgeting At the end of January 2007 Stryker Corporation, headquartered in Kalamazoo, Michigan, released operating and financial data for the fourth quarter of 2006, completing the picture of 2006 as a whole. The company's performance was strong; indeed, it was the latest in a string of strong performances going back many quarters. Sales of $5.4 billion for all of 2006 reflected an increase of 11.0%. EBIT grew by 15.6% to $1.1 billion. Net income was $778 million compared to $644 million in 2005, reflecting growth of 20.8%. It was Stryker's seventh straight year of double-digit growth in net income. Exhibit 1 presents summary operating and financial data for Stryker for the ten-year period 1997-2006. Exhibit 2 presents financial statements for the years 2005 and 2006. The performance of Stryker's stock mirrored its strong operating results. Earnings per share grew 20% from 2005 to 2006 . Even more impressive, the compound average growth in earnings per share over the preceding 30 years exceeded 20% per year. Not surprisingly, the company's stock price surged during this period. At the end of January 2007 Stryker's shares closed above $60 per share, posting a gain for the year of more than 24%. Gains recorded by the stock over the preceding ten years were similar. A $10,000 investment in Stryker stock in January 1997 was worth almost $90,000 in January 2007, a compounded return of nearly 25% per year, not including dividends. At current prices, the company's market capitalization exceeded $25 billion. Exhibit 3 shows Stryker's stock price performance during 1997-2006, adjusted for two 2-for-1 stock splits. At December 31, 2006 Stryker's balance sheet showed long-term debt of $14.8 million against total assets of $5.9 billion, of which $1.4 billion was cash and marketable securities. These figures reflected a striking long-term trend of declining leverage. Nearly ten years previously, in 1998, Stryker had doubled its size by acquiring Howmedica, a major producer of orthopaedic implants, from Pfizer, Inc. for $1.65 billion. By comparison, at the end of the prior year, Stryker's total assets had been less than $1.0 billion and its long-term debt less than $80 million. Stryker borrowed heavily to finance the acquisition of Howmedica and consequently its debt ballooned to $1.5 billion in 1998 . Net income fell in 1998 and again in 1999 before turning around in 2000. Since then earnings had resumed their steady 20% per year growth rate, and Stryker's debt was steadily reduced until it reached $26 million at the end of 2003. In the same year, the company's cash balance began growing rapidly, as shown in Exhibit 1. Given its track record, one of the toughest challenges facing Stryker in the decade ahead was how to keep it up. Sustaining the performance would require continuous investment in both new and 4 The Approval Process The approval process for large CERs had been modified in recent years to increase the spending authority thresholds at the Division and Group levels, institute more formal, standardized procedures, and require more rigorous analysis and documentation. The standard CER forms were also redesigned and came into usage along with the modified procedures in 2005. Partly as a result of the changes, the number of CERs requiring centralized approval fell from about 300 per year to about 30 per year. As part of the change, a Capital Committee was constituted and formally charged with reviewing and approving large CERs. Members of the Capital Committee included Stryker's CEO, CFO, Treasurer, Controller, General Counsel, VPs for Tax and Business Development, and the Director of IT. To receive spending authorization, a large project had to be approved by both the CEO and a majority of the other Capital Committee members. Each CER had a desi grated sponsor who served as liaison between the proposing division and the Capital Committee. Operational CERs were sponsored by the Controller. M\&A CERs were sponsored by the VP for Business Development. CERs for IT systems were sponsored by the Director of IT. The sponsor had several tasks to perform. The first part of the job was to assist the division in preparation of the CER and supporting documentation to ensure that it met Stryker standards for quality and completeness. Second, the sponsor coordinated the submission of the completed CER to ensure that Committee members all received complete information. Third, the sponsor served as an interface between Committee members and the division regarding requests for additional information and condi tions to be met for approval. Internal guidelines specified a timetable for submission, review, and disposition of CERs. These were intended to ensure that adequate time was allowed to review spending requests and to minimize the need for "emergency" approvals. In general, the guidelines provided for a minimum of two weeks between the time a division notified the appropriate sponsor of it intent to submit a CER and the formal consideration by the Capital Committee of the CER. About a week was devoted to a review process between the division and the sponsor, and another week set aside for review of the submission by individual Committee members, who could request additional information. The System in Practice: 2007 In early 2007 participants in the new process were still getting used to it. Some of the goals for the revised system were being met: more data, more depth, more analyses, more standardization and rigor. But there were complaints as well. The stipulated timetable for CER submission and review was not always met. Committee members complained about CERs not being submitted on time. Divisions complained about the Committee not being available as such when needed. Indeed, the Committee did not hold regular meetings as a group, but operated more as a "virtual" committee with members contacting one another as needed. The requirements for standardization and extensive documentation struck some managers as unnecessarily bureaucratic for proposals that were "no-brainers" and clearly assured of approval. Indeed, "The vast majority gets approved," controller Jim Praeger observed, "but recently a few CERs have not been approved." Finally, the heavy corporate involvement in the process clashed somewhat with Stryker's decentralized organization and entrepreneurial culture. One division executive said simply, "It's painful." This document is asthorized lor use orly by John Aichards (jphn.ichands sas Agmal com). Capying or posting is an intingenert of copyright. Please cortact customenevicelianardousiness org or 8009880895 lor addions copies
