There are a few different issues that can affect the function of a floppy drive.
If you have a machine based on the 604e processor running at 180MHz or faster, you need to have either the "PowerMac Format Patch" or the "Floppy Tuner" installed in your Extensions folder. This extension allows the 604e based machines to format floppies.
If you are using an ATI video card verify that you are using the Spinnaker II driver, version 1.1f2. This version of the driver will allow the machine to format floppies while the ATI card is installed. This issue is associated with the ATI cards and all MacOS based machines.
If neither of the above two solutions fixes your floppy drive issue, try booting off of the Power CD. Once you have booted from this CD see if you can format the floppy. If you can then there is a system software problem. Try a clean install of the system software. If you still can not format floppies then give technical support a call for further assistance.
Machines Affected: PowerCurve PowerCenter, PowerTower, PowerTower(e), PowerTower Pro