DISCUSSION (continued 3)

1989 3,566,223,557 351,902,957 31,162,907 3,949,289,421 610,724,301 413,390,359

Total 11 years $43,834,194,155 $5,335,310,738 $101,910,969 $716,143,616 $49,987,556,478 $9,806,639,521 $6,754,340,598

Average 11 years 3,984,926,469 485,028,249 9,264,634 65,103,965 4,544,323,317 891,512,684 614,030,963

1890 $2,927,221,233 $283,407,139 $35,262,205 $3,245,890,577 $524,767,906 $348,388,268

Total 12 years $46,761,412,388 $5,618,717,877 $101,910,969 $751,405,821 $53,233,447,055 $10,331,407,427 $7,102,728,866

Average 12 years 3,896,784,365 468,226,489 8,492,581 62,617,152 1,436,120,588 860,950,619 591,894,072

TABLE 13. (Continued.)

Year. Net Operating Revenue. Net revenue from outside operations. Total Net Revenue. Taxes. Operating Income. Operating ratio. Percentage to cost of road, cost of equipment, material, and supplies Mileage of line owned.

1909 $331,591,883 $2,425,726 $334,017,609 $37,397,973 $296,619,636 67.88 5.738% 56,563.41

1908 302,970,890 3,446,600 306,417,490 36,021,974 270,395,516 71.13 5.287% 56,328.79

1907 346,225,313 346,225,313 35,876,148 310,349,165 69.66 6.063% 56,415.25

1906 330,091,457 330,091,457 34,863,314 295,228,143 68.40 6.071% 55,990.12

1905 286,468,161 286,468,161 27,675,211 258,792,950 69.68 5.542% 54,963.20

1904 263,651,302 263,651,302 28,091,468 235,559,834 70.70 5.304% 54,643.50

1903 269,833,327 269,833,327 26,537,954 243,295,373 69.04 5.630% 53,873.11

1902 254,293,667 254,293,667 25,297,465 228,996,202 67.52 5.472% 52,980.70

1901 238,932,245 238,932,245 28,797,264 215,134,981 67.30 5.235% 52,911.46

1900 230,906,736 230,906,736 22,616,893 208,289,843 66.94 5.146% 52,495.25

1899 197,333,942 197,333,942 21,692,694 175,641,248 67.69 4.447% 52,009.93

Total 11 years $3,052,298,923 $5,872,326 $3,058,171,249 $319,868,358 $2,738,302,891 68.88 5.478% 599,174.72

Average 11 years 277,481,721 533,847 278,015,568 29,078,941 248,936,627 68.88 54,470.45

1890 $176,379,638 $176,379,638 $14,753,550 $161,626,088 66.39 4.980% 43,094.73

Total 12 years $3,228,678,561 $5,872,326 $3,234,550,887 $334,621,908 $2,899,928,979 68.75 5.448% 642,269.45

Average 12 years 269,056,547 489,360 269,545,907 27,885,159 241,660,748 68.75 53,522.45

241If there were not abundant evidence that the railway industry is not excessively profitable, there would be more reason on the side of those who continually put forward new schemes of restriction; but, not only is such evidence ample, but there is no evidence of any sort tending to establish the contrary. Limiting the inquiry to the region east of the Mississippi and north of the Ohio and Potomac Rivers, commonly known as Official Classification Territory, the statement in Table 13, based on the book cost of railways, with their equipment, supplies, and materials on hand, is instructive. The data are from the reports of the Interstate Commerce Commission.

The amounts shown in Table 13 as "operating income" are, as should be remembered, those earned, and not those distributed as interest on bonds and dividends on shares, which were necessarily much smaller. Bearing this in mind, it is significant that the percentage of such operating income to cost of property has not but once in the last twelve years, the most prosperous duo-decade in the Nation's history, exceeded 6%, and then only by a very small fraction; and that the average for the whole period is less than 5½ per cent. Every one knows that the real value and the actual cost of the railway property in this region greatly exceeds its book cost, so that these percentages are undoubtedly much in excess of the real rates of net earnings to value or cost of property.

P. E. Green, Assoc. M. AM. Soc. C. E. (by letter).—It is not often that there is presented to the Society a paper which shows such thoroughness of understanding of a difficult problem, and as much real experience in its solution, as is manifested therein; and the author is certainly to be congratulated on such a logical and forcible presentation of the subject. There may be some points on which engineers who have been engaged in such work cannot agree with him; but certainly it cannot be said that he has not argued very clearly and logically on nearly all the debatable questions.

Those who have not had actual experience in making a valuation of a railway company's property cannot have any idea of the enormous amount of detail and labor necessary to make such a compilation of any real value. It simply means that every detail of every structure of whatever kind must be investigated, together with the various considerations covering "intangible values," which the author has so ably discussed.

The writer was fortunate enough to be employed on the valuation of the Chicago and Northwestern Railway property in Minnesota in 1906, and possibly some details of the manner in which the actual field work of the survey was done may be of interest.

The work consisted of making a compilation from records, or from actual surveys when necessary, of about 625 miles of railway property, including several important terminals. The property had been built between 1860 and 1901, mostly in the early part of this period. The portions which had been constructed during the latter 242part of the period, say from 1890 to 1906, presented no difficulties, as the records were very clear and complete, but the portions constructed in the Sixties had practically no records. Some had been built by small independent companies, which were acquired later by the Northwestern System. On these old lines the records were practically nil, and those in existence were soon found to be of absolutely no use. Even on the newer lines it was found that many changes had been made within a few years after their construction, and that it was sometimes more economical, as regards time at least, to make a new survey of the property than to use the records.

After examining all the old records very thoroughly, and endeavoring to get some order and information out of them, it was decided that the only way to do the work properly was to make a complete survey and valuation of all the physical property. Several field parties were organized and also an office force, about twenty men being put on the work. The parties ran levels for profile purposes, cross-sectioned cuts where necessary, noted evidences of clearing and grubbing, of the character of the cuts, and the disposal of the material, examined the ballast for depth and character, examined the rails for age, weight, and condition, and noted the kind and condition of the fences, gates, farm crossings, planking, whistle and highway-crossing posts, culverts, bridges, and in fact every detail of construction. Advantage was also taken of the survey to re-station the lines, to paint such stations on the rails, and to set permanent posts, so that afterward the stationing could be picked up at any time with little trouble.

In this way there was accomplished much work of value to the railway company, for which there had been a demand by the division officials for years, but which had not been done because of lack of men and money.

No attempt was made to assign depreciation, as regards the rails; this was determined afterward, from the age of the steel in the track. It was necessary, however, to make quite a thorough inspection of the ties, and to note their condition, as they were replaced year by year singly as they wore out. Almost every conceivable kind of timber had been used for ties at one time or another. Treated and untreated ties lay side by side; and thus there was great difficulty in classifying them with regard to the kind of timber. With bridge ties and timbers of frame and pile bridges, there was not so much difficulty, as they were open to inspection, and had been inspected twice yearly by the Division Engineer and the Superintendent of Bridges and Buildings, and accurate records of their condition and renewals had been kept. The depth and condition of the ballast also varied very widely.

In a very short time all the men on the survey became well acquainted with the character of the work they had to do, and, as the work went on, the progress of the party day by day was very much 243more rapid. At the beginning of the survey, a progress of 6 or 7 miles of single track was considered a very good day's work; at the end of the survey, the parties were making from 12 to 15 miles per day.

There was considerable difficulty in setting proper values on the hundreds of buildings, large and small, owned by the railroad. Most of these buildings had never been constructed from plans, and it was difficult to calculate what they had cost originally, and what it would have cost to build them at the time of the survey. However, time books were searched, and the contents of the buildings in board feet were calculated, and, while in many cases their age was not known from any records, it was nearly always possible to find out from somebody just when they were erected.

As intimated before, the railway company derived much actual benefit from the work, outside of the accurate knowledge obtained as to the value of the property itself. Steel charts, bridge records, etc., were established, and profiles, stationing, continuous bench-levels, etc., were all re-run or re-established; thus making the engineering work of the future more consistent and uniform, and enabling more work to be done with a smaller force. New maps of all the station grounds and terminals were obtained, and all the records were put in better shape than they had ever been before.

Examination of some of the old terminals brought to light many strange and out-of-date conditions. Old wrought-iron rails of antiquated pattern, old cast-iron frogs, etc., of a pattern which had not been in general use for fifty years, were found in the track. On some of the little-used sidings, the old wrought-iron rails were so worn that the tread of the rail was entirely gone, only the web remaining to carry the traffic, and such rails were still in use.

In such a valuation, also, many items, some of considerable magnitude, were found which were extremely difficult to classify and assign to their proper place. Such a one, for instance, as a soft, sand rock deposit beside the track, which for many years had furnished engine sand. Many thousand cubic yards of this material had been excavated, but it had not gone into the roadbed as ballast, or to make fills, or to widen embankments. It would hardly have been proper to classify such excavation as grading, for it was an item of engine maintenance and train operation. This is only one of numerous problems which had to be solved.

After all the survey had been made, most of the work of compilation had to be done. Some of it had already been done in the office by the small office force, but the great mass had to be done by the men who did the work in the field. This task was of almost incomprehensible magnitude. There were thousands and thousands of items, and such a great mass of figures that the ordinary man would become lost 244in the maze. The data had to be checked and re-checked by men who were not accountants, and sometimes most ludicrous mistakes were discovered. However, it was at last accomplished, and the writer's recollection of the "Present Value" of the Chicago and Northwestern property in Minnesota is that it was somewhat more than $23,000,000 for the entire mileage (about 625 miles), or an average of about $37,000 per mile of track. Hardly any of the mileage would be called high-class or trunk-line track, but most of it might be classed as second-class or important branch-line railway.

E. Kuichling, M. AM. Soc. C. E. (by letter).—This paper is a very valuable addition to the literature of a comparatively new subject that is rapidly attaining great political importance, and it gives abundant evidence of deep research and thought by the author. The reasons for determining the true value of such properties, as well as the general principles of making the valuation or appraisal, have been set forth so clearly and convincingly that little can be added in this respect; hence, there is room for comment only about details.

One of the perplexing questions is the determination of the proper value of the right of way and real estate of a railroad. The land was originally acquired at a certain cost, essentially for public use, and in the course of time its value, as determined by reproduction cost, usually becomes greatly increased by the development of the adjacent land by its various owners. Without the railroad, such development and appreciation of land values would probably not have occurred, and, therefore, it has been argued by many persons that, for taxation purposes, the railroad lands should be appraised at only their original cost, while, for capitalization purposes, they should be appraised at a value measured by that of the adjacent land at the present time. This claim is based on the theory that the railroad is like any other piece of public work, such as a canal, highway, or pavement, which is built for the use of the public, and on which no tax is levied by State or municipality. On the other hand, it has been held by some of our Courts that a proper valuation must take into account the appreciation or depreciation of land values; but, as the opinion of a Court is not unalterable, the soundness of this doctrine cannot be regarded as permanently established.

The author states^[41] that there can be no serious objection to this doctrine in relation to rights of way in the country and small towns, although he admits that it is subject to exceptions in the case of cities and terminal and dock properties. It will be of great interest to learn his reasons for making such exceptions in the case of the most costly lands, and whether the valuation of such lands should be more or less than that of similar adjacent lands used for other purposes. From the context the inference may be drawn that the valuation should be somewhat 245higher than that of adjacent similar land in the case of a steam or interurban railroad, because its holdings form a continuous strip; but to the writer this reasoning does not appear satisfactory. The statement of the Court, that "the value of land depends largely upon the use to which it is put and the character of the improvements upon it," does not necessarily involve a higher valuation of the property than its cost, and it is quite conceivable that the actual value of the property after being taken by a railroad may be much less than it was before. The only reason in such a case for maintaining the purchase price is to conserve the general valuation of the adjacent similar real estate.

In dealing with the subject of depreciation, the author has been very brief, as he did not consider it essential for the purposes of the paper. This is to be regretted, as depreciation is an important feature in every valuation, and so few trustworthy data concerning it are available. The value of the paper would be greatly enhanced if the author would give the assumed average life of the principal components of a railroad, based on some definite traffic, and normal grades and curves. Much diversity of practice in this respect prevails, and the final judgment of the numerous experts who were engaged in the Michigan valuations cannot fail to be of great interest. The same remarks are also applicable to the unit prices adopted for construction and equipment.

The subjects of expenses for organization, engineering, administration, contingencies, and non-physical values are treated very thoroughly by the author, and particularly interesting is his discussion of the complex question of franchise value. After quoting from numerous judicial opinions, he reaches the conclusion that the franchise simply protects the owners of the property in their enjoyment of the earnings, and that its value merges into the "fair value" of the property and becomes inseparable from the other non-physical elements of value; also, that the aggregate non-physical value of the property depends only on the net income for a period of years. This method of estimation certainly has the merit of being simple, rational, and free from all hypothetical considerations. It is, however, obviously governed by the rates charged for the services rendered, and if these are likely to be altered at any time by governmental action, a corresponding alteration in the "fair value" of the property will take place.

This consideration brings us at once to the intricate question of reasonable rates, which involves the matter of reasonable design and construction of the property. In most cases the working capacity of the plant must be much greater than the average annual demand for the service performed, as so-called "peak loads" of relatively short duration must be provided for. The magnitude of these peak loads, however, varies with the subsequent development of the territory, which is necessarily conjectural; hence it follows that a comparatively large 246amount of capital is often invested in an enterprise for the purpose of taking care of such anticipated temporary demands, and on this investment a "fair return" should be granted. This condition is particularly noticeable in municipal water-works plants, where provision must be made for supplying water for fire service to an extent which may be several times greater than the normal hourly rate of consumption. In the case of railroads, such demands can usually be met by adding to the rolling stock at moderate expense, while in a water-works the outlay is relatively greater because the entire plant must be adapted in the outset to the anticipated maximum delivery in the course of a comparatively long period of time.

The problem of rate-making has been excluded by the author from his present paper on valuation; but, inasmuch as he is so well qualified for the task, and also because the non-physical value of the property depends mainly on the rates obtained for the service rendered, it is hoped that he will deal with this feature in a subsequent paper, thereby bringing out a discussion on the obscure subject of "fair return." It is noticeable that these phrases occur frequently in judicial opinions, but the fundamental principles on which a definite conclusion should be reached are seldom set forth clearly.

Richard T. Dana, M. AM. Soc. C. E. (by letter).—The solution of this problem includes practically all the factors in the general subject of economics, in which engineering occupies a large but by no means preponderant part. Mr. Riggs has done some very valuable and pioneer work in contributing this paper at this time; and the writer, in calling attention to what appears to be a radical error in it, does not wish to be taken as attempting to detract in any way from its great value as a whole. It is most important, in the inception of such an investigation, on the part of the members of this Society, to remove from the subject the stumbling blocks as they appear.

The author makes the following statement:

"It is true that the 'value' of a property is an unstable figure, subject to fluctuations due to natural or artificial causes, and that a material change in value may occur suddenly, but the 'value' of any given property on any given date is, or should be, from an engineering standpoint, a definite sum which may not be varied or changed to suit the whim or will of the people for whom the work is done."

The fundamental conception of a value is so important in an investigation of this kind that it is worthy of careful and thorough discussion.

The appraisals which the writer has had occasion to make have generally been for one or other of the following purposes, namely:

(I)

Taxation, in the interest of the community or corporation taxed;

(II)

Bonding, in the interest of the banker or representative of persons who contemplated lending money on the property;

(III)

Rate-making, in order to determine what was a fair amount of money that the property should be allowed to earn for the owners.

247Now, in general, a proper value for any property for any one of these purposes is different from its proper value for any of the others. This proposition is of immense significance, for the reason that, if the value for the property arrived at, on one basis, be accepted and applied for one of the other purposes, it will inevitably result in gross injury and financial loss to some one.

In attacking this problem, one must be careful to take the correct standpoint, which is not necessarily that of engineering. Engineering science is indispensable for a large part of the work, but there are other indispensables, which would not ordinarily be recognized as engineering. The writer takes the view that engineering is a part of economics, rather than economics being a part of engineering.

To illustrate this point, consider two objects, one of which is concrete and simple and the other more complex.

(1) A steam shovel belonging to a railroad, costing $10,000, new;

(2) The entire railroad as an operating entity.

Assume for (1) that the shovel has been purchased recently, is in perfect condition, and that the railroad has some work for it to commence on as soon as it can be properly installed. What is its:

(I)

Taxable value,

(II)

Bonding value, and

(III)

Rate-making value?

(I) The tax assessor cannot properly appraise it at $10,000, because it certainly would not sell for that sum, and if the community should have to sell it for taxes the actual return minus the charges would be so much less than the $10,000 that the community's books would show a heavy loss; and this practice, if largely indulged in, would bring the community into financial straits. The community must be exceedingly conservative in its estimate, for this very reason; and, therefore, it has been customary, almost universally, to tax such articles practically on their sale value at what might be called panic prices. The company which sold the shovel to the railroad would not buy it back two days after the sale for more than the original price minus what that company considers its selling charges, say 20%; so that, in this case, even if a customer were at the door, the shovel would not be worth more than $8,000, and a fair tax appraisal could not consistently be more than $8,000 minus charges of, say, $250, or $7,750.

(II) Assuming that the railroad is a very small one, that it wants to borrow money, and desires to put up the shovel as collateral for the loan. What would be its loan value to the lender? In considering this point, it is necessary to assume that no aid is rendered by the credit of the railroad itself, but that the protection for the loan is to be 248furnished by the shovel only. Now, the banker will reason that, in the event of the note remaining unpaid, he will have to sell the shovel to reimburse the bank for its loan, and he will be required to consider the matter on a conservative basis. He cannot lend on the shovel up to its full value, for in the first place it is not a "negotiable security." If it were a security, with a free market on some stock exchange, he would probably lend to the amount of 80% of its value, but a steam shovel in a sand bank on a railroad is by no means as convenient of exchange, nor as easy to foreclose on as a stock certificate in a banker's box; therefore he will lend, or he ought to lend, less than 80% of its sale value, minus the selling charges. If he lends more than this, he is lending on the credit of the owner of the shovel rather than on the shovel itself. Granted that the maker of the shovel is willing to buy it back at its full selling price less the selling cost, the maximum loan value of the shovel would be a little less than 64% of its purchase price, or $6,400. To lend more than this on the shovel would not be conservative banking.

There is another bonding or loan value to this shovel, when it is considered as part of the assets of the railroad, the bonds of which are to be held by the banker, under which circumstances a higher value than $6,400 would be admissible.

(III) If the value is to be determined with a view of ascertaining what is a reasonable figure that the owner of the shovel ought to be allowed to earn as a public utility organization, the problem is entirely distinct from the foregoing two cases. Assume that the railroad is entitled to earn at least 6% on its investment in the shovel. Now, its investment is $10,000, because that is the money that it cost; and nothing had been credited to its account, since the shovel had just been purchased and had not yet done any work. The shovel cannot be considered as being worth more than its cost, and it can easily be shown it is not worth less for rate-making purposes.

These three illustrations, which are very briefly outlined, should demonstrate the fact that there is almost no relationship between any two of the different kinds of value which are being considered.

Now, from the standpoint of the railroad as a whole:

(I) Should railroad property be taxed on the basis of what the entire railroad would bring on a foreclosure procedure? Obviously not, because the railroad is taxed in sections. The Town of Squedunk will tax the portion of the railroad that lies within that town, and will have considerable difficulty in putting down as security for its own bonds the locomotives and cars which go through once a week or twice a day at 40 miles per hour. To cover partly the flitting assets, it taxes the railroad on a franchise value. It may tax a railroad's land on the same basis that it taxes land owned by private individuals, notwithstanding the fact that when the railroad buys the right of way it 249generally has to pay more money per acre than the householder or the farmer. This unit cost to the railroad may be two or three times that to the farmer, yet the writer has never heard of a community attempting to tax railroad property two or three times as heavily as adjoining property used for private or commercial purposes.

(II) On the other hand, this same property is an absolutely sound asset for the railroad, and the railroad probably bought the property from the proceeds of the sale of bonds. If the public service commissions were to rule that the railroad may be allowed to issue bonds only to the amount of the taxable value of the property which is to be held as security for the bonds, the result would be an absolute paralysis of railroad construction. A bond is an obligation to pay so much interest for so many years, and to pay back the principal at the end of its term. The bondholder is interested in the absolute regularity of his interest, and in the security that lies behind the principal, and it is to-day the custom of banking houses to consider a bond well secured when, in a territory of reasonably rapid growth, the principal is earning say twice the interest on its bonds, and when the cost of reproduction is in excess of the amount of the bonds, provided that the property is in good physical condition. If it should be necessary to foreclose on the bonds, it is then reasonable to suppose that some one else will buy it in for at least the amount of its bonded indebtedness. What can this possibly have to do with the taxable value of the track in the Town of Squedunk? One may be 1.5 times the other, or three times the other, depending on a multitude of circumstances.

(III) The value of the property for rate-making is a complex one to determine, and, of course, there is no opportunity for a full discussion of it here. One point, however, will serve to establish thoroughly the difference between this and taxable or bonding value. If the community is prosperous and the business is a good one and honestly managed, the railroad ought to be allowed to earn a reasonable percentage, say, at least 6%, on what has been put into it. If the community should decree otherwise, then people will not build railroads for investment purposes, and all will lose money. Now, it is a well-known fact that a new railroad's earnings have to grow for several years before they are on a normal basis, and part of what the owners of the property have put into it is, for example, the interest on its cost before its earnings are on a normal basis. This may amount to a considerable percentage of the original construction cost of the property, if the business is several years in developing. Granted that the community ought to allow the property to earn a reasonable interest on what has been put into it, then the rate-making value will be very much larger than the sum of the taxable valuation of all its different parts. It will also be much greater than its bonding value, because, as a bond proposition, it can borrow money up to a limited percentage of what it is actually worth.

250George T. Hammond, M. Am. Soc. C. E. (by letter).—The engineer called on to fix the valuation of public service corporation property has so little engineering literature on this special subject to guide him that he must feel grateful to the author of this excellent paper for adding so much of a kind that is very desirable.

Estimating the cost of an engineering structure in advance of its construction is one of the most ordinary professional duties, but how difficult it actually is, and how much engineers differ with one another in their estimates on the same structure! Perhaps there is no professional duty which calls for so much study and so much experience, or which tests so closely the ability and capacity of the engineer. How seldom professional estimators agree with each other; or designing engineers with contracting engineers; as witness the bids received at the public lettings of contracts when compared with the engineers' estimates of cost; and, if this is true, which no one will attempt to deny, how much more so is it probable that estimators will disagree when they attempt to place a value on works already completed, and in service, perhaps, for many years, in which various changes in value have occurred, and in which questions of fact are mixed with legal questions involving legal rights, as well as financial questions.

The tendency in all such valuations appears to be a mixing up of things in general—like the witches' stew. Everything goes into the pot and is boiled together until all becomes soup, at least until the official commission, like the witches, considers it done and ready to be served up in the form of a report. It is then observed that the substance served out is of a complex nature; that the valuation of engineering structures has become mixed with other and uncertain values; that the whole value, as stated, is, after all, little better than the commission's opinion of the value; and that another commission would reach a different conclusion.

The author states that the valuation of corporation property:

"Should be the honest judgment of the men composing the commission, as to the actual cost of reproduction, present physical value, or 'fair value,' and should be ascertained by a systematic and scientific method which takes into account all the facts concerning the property, its physical value, its strategic location, its operating revenues and expenses, and its franchises, rights, competition, opposition, and all other tangible or intangible elements, which would affect values. The method of valuation should be such as to minimize or entirely eliminate all differences due to errors of personal judgment."

This, it seems, complicates actual present values with conditions which might, or might not, continue. Outside of the physical valuation of the plant, which offers the easiest problem presented, how can one fairly put a value on operating expenses and revenues, which might be affected favorably or advisedly by good or bad management, 251and by numerous other complex and almost incomprehensible circumstances.

The tendency of all such commissions seems to be to confuse together and mix up some things which are logically separate. Thus, the value of the plant and franchise, good will, and present investment or income value, etc., are too often taken together. The value of the plant is dependent on the cost of reproduction, and also the depreciation of the structures, as engineering structures, and should be based on present prices for which the work could be replaced, minus the depreciation, which is a question of engineering judgment and experience. The other items of value are largely dependent on the situation of the plant and its prospects as an income-producing property, and this again is a matter of opinion, in which the opinions of financiers and investors are sometimes of more moment than those of engineers. The opinion of lawyers as to the value of the franchises and the cost of the legal complications possible or probable must also enter into any seriously worthy opinion as to value.

The few salient lights in the picture of valuation, presented by the author, serve especially to reveal the darkness which involves the whole subject of valuation, estimating, and the use of cost data for such purposes, and to suggest that, with all the wonderful progress on the theoretical side of the profession, engineers have as yet advanced but little in this division of the practical side—cost data, valuation, and estimating. Engineers cannot compare the results of different estimators and appraisers without sorrow and even shame for their ignorance, or their incapacity to agree in the application of scientific principles and the results of practical experience to this branch of their work.

At present we would seem to be a long way from a method of valuation, "such as to minimize or entirely eliminate all differences due to errors of personal judgment."

The method described as having been used by Professor Adams seems to be at least an advance toward a logical and rational method of getting at the value of corporation property, but it must be acknowledged that we are as yet a long way from a perfect method of appraisal, even of the physical values, to say nothing of the non-physical. He held that as nothing visible or tangible gave support to the latter value, it must be determined on the basis of information secured from the income accounts of the company. This method of measure, it would seem, is not unlike the celebrated dictum on the length of the Chancellor's foot, "some Chancellors have a long foot, and some an indifferent foot, and some a short foot"; therefore, a great English Chancellor says, "the length of a Chancellor's foot should not be taken as a measure of rights in equity." Thus, if the income of the company is to be taken by the appraising engineers, or the gross income, it may have to be given a different interpretation from the net income, and 252if the surplus earnings depend on transient causes or on excessive rates for service it will lead to a totally erroneous conclusion. The same may be said if the rates for service are too low, or if the company is badly managed, or is carrying a great deal of "dead wood," either in the form of property or of servants. Therefore, it seems evident that he who attempts to follow this method of appraisal must possess almost superhuman judgment of present conditions, and prescience to forecast the future, as well as a grade of wisdom and knowledge of existing conditions of trade and industry which may be also characterized as superhuman. In order to apply Professor Adams' method justly, we must know whether the company is wisely managed, whether its income is a fair income, whether its physical property is all useful and needful, whether its service is what it ought to be as to efficiency and economy, etc. We must assume an ideal condition of commerce and industry, and of property value and management, and then appraise the company's property by comparing it, consciously or unconsciously, with this ideal. Possibly this is the best method devised so far, but surely it leaves a great deal to be desired; and it is difficult to see how different engineers, on different sides of the question, representing different interests, can find any common ground of agreement in Professor Adams' method. Under such circumstances, engineers are likely to differ in their results as much as the length of the different Chancellors' feet.

Leonard Metcalf, M. Am. Soc. C. E. (by letter).—Mr. Riggs has done engineers, and more particularly those interested in valuation works, a genuine service in presenting to the Society this admirable paper.

No shrewd observer can fail to recognize the increasingly insistent demand of the public for greater publicity in the accounting, and a larger measure of governmental control in the operation, of public service corporations. In its best form, such control will be welcomed by the corporations, as giving greater stability to investment in such property; in its worst, it may prove a serious limitation to prompt development of the best standards of service. In the water-works field, the anti-corporation movement has resulted in taking over by the public many such plants. It does not seem likely, however, that we are ready to go farther in the railroad field of operation than to demand reasonable regulation of such corporations.

While the writer has had no experience in railway management or valuation, he has devoted much time and thought to the valuation of, and determination of fair-rate schedules for, water-works properties; therefore, what he may have to say in comment on this paper may be assumed to have direct application to water-works valuation, and to railroad valuation only as the similarity in the public service rendered by these corporations may imply.

253In the main, the writer subscribes heartily to the views expressed by the author and the temperate way in which he has expounded them. Space forbids discussion in detail of all the matters alluded to and so well covered by Mr. Riggs. On one important subject, however—the inclusion of the going value, or going concern value, of public service corporation property, in the intangible property values, rather than in physical plant value, and the consideration of it as an intangible value rather than as a real and substantial item of cost to the public service corporation—the writer differs from the author. It is clear, from what Mr. Riggs has said, that this is debatable ground, and, from the care and fairness with which he has expressed his views on this subject, one might almost be led to infer that he invites attack on it. It is in no carping spirit of criticism, however, that the following views are expressed.

As the writer has recently submitted to the Publication Committee of this Society a paper on the "Going Value of Water-Works," written by him in collaboration with John W. Alvord, M. Am. Soc C. E., in which a detailed discussion of this subject will be found, only enough will be said to outline clearly his point of view.

The author says:

"The physical property is that which enables the corporation to do business. Without physical property it could not produce the commodity which it sells. The amount of money actually invested in acquiring that physical property represents the measure of capital on which it is morally entitled to earn interest and profit; and, in the stage of promoting and financing the enterprise, all hope of earnings is based on the amount of money required to construct the property."

He also says:

"It would seem reasonable to say that this difference between the physical value and the value based on earnings represents the 'good will,' 'established business,' or 'going value,' and all other non-physical elements of value."

In referring to going value, he says:

"* * * Yet, to fix a value on it by the method described by him [Mr. Alvord] involves going into the realm of conjecture and speculation to a degree that could never be sustained. * * * It can be readily seen that the physical present value is not always—indeed, is not often—the 'fair value.' The 'fair value' may be more, or less, than the present value of the physical property."

"* * * Is it not, then, proper to conclude that the non-physical or intangible value, composed of all these various elements of value, can only be determined absolutely by a study of the earnings and operating expenses? * * *"

He also says:

"The contention that all the different elements of non-physical value merge into one intangible value, not capable of separation, will 254doubtless be objected to by many engineers and corporation managers. * * *"

"The writer does not concede that 'going concern' is a proper element to consider in the physical value, as it does not represent any part of the cost chargeable to capital, and the physical valuation should be confined to the determination of capital invested."

Quotations might be multiplied. Those cited, however, will suffice to recall the author's view, and to make clear the point with which issue is taken.

Is Mr. Riggs right in his contention that going value is in fact an intangible value; that going value is not an element of real cost to the company, involving investment of capital; that going value, therefore, should not be included in physical plant value; and that the company is not morally entitled to earn interest and profit on it?

The writer contends that going value is as real an element of cost, in the property of any public service corporation, as is the cost of any portion of its physical plant. It pertains, however, to the business, rather than to the physical plant, of the corporation.

Whatever the difficulties of its computation may be, whatever the methods used—whether that adopted by the Wisconsin Public Service Commission (which is essentially one of determining the original cost of the going value and not its reproduction cost), or whether that perhaps first outlined by Mr. Benezette Williams and George H. Benzenberg, Past-President, Am. Soc. C. E., in the Middle West, and by William Wheeler, M. Am. Soc. C. E., in the East,^[42] a method which seeks to determine the reproduction cost of the going value, rather than its original cost—the going concern value has come to be recognized, by water-works appraisers at least, as a substantial element in the cost of the plant, and hence as differing essentially from the franchise element or so-called unearned increments of value.

Is not going value in a "between" class—a middle ground between tangible and intangible values—tangible in that it has involved real cost and expenditure of money; intangible in that it is not as readily calculated as are other reproduction cost items, is dependent fundamentally on the earnings of the company, and that there is no tangible equivalent to show for the expenditure, except the existing income of the corporation? Surely its character is quite different from that of the franchise, as ordinarily found, the value of which, while real, from the rate-payers' point of view, seems to be made out of whole cloth; in short, seems to be of fictitious value.

Certainly, the conjectural and speculative character of the computations—as referred to by Mr. Riggs—involved in the determination of going value is no excuse for failure to recognize going value as a 255real element of cost, rather than as an intangible value. As a matter of fact, the variation in the views on going value, by engineers who have given this subject particular study, while greater than the variation in their estimates of the reproduction cost of the physical plant, is still far less than the variation in their views on franchise value.

As bearing on the proper basis for rate-making, the author's statement, that the "* * * physical property represents the measure of capital on which it [the public service corporation] is morally entitled to earn interest and profit * * *" cannot be admitted, equitably or legally; and it is not to be assumed that Mr. Riggs desired to imply that this sentence summed up his final views.

Are we not, however, approaching a basis of rate-making, predicated on the earning, by public service corporations, of operation and maintenance expenses, depreciation allowance, and return (i. e., interest and profit) on reproduction cost of the property, less accrued depreciation, plus going value, plus a nominal allowance for the franchise and other intangible values of the corporation? Is it not possible that the recent depression in the business world has been due, in considerable measure, to the shrinkage in the values ascribed to franchise and other intangible value in public service corporation property?

If we are approaching such a limitation, it is the more important that the public should be educated to the fact—not theory, for it is a fact—that going value, or going concern value, is a real element of cost, covering an outlay in effort and money on the part of the corporation, and as such is as much entitled to earn a return (interest and profit) as is the other capital invested in plant. It is not on any items of real and necessary cost to the corporation that the public objects to paying tribute, but on the "unearned increments" and the virtual monopoly "privileges" enjoyed by the corporation and created, in large measure at least, by the public itself and by normal conditions of growth and development for which the public, rather than the corporation, was perhaps responsible—though in many cases it may be urged truly that the corporation itself, rather than the public, has been responsible for the development.

Such a basis of rating, while still dependent on sound judgment and judicial treatment, is nevertheless not beset with the speculative element involved in the capitalization theory, which, Mr. Riggs himself admits, fails as a basis of rate-making except when predicated on fair rates.

If the writer's contention, that going value is a real element of cost in the property of any public service corporation, is sound, Mr. Riggs' statement that, "It appears to be doubtful whether the Court can be construed as approving such an element of value in rate cases," and his interpretation of Judge Tayler's ruling in the Cleveland Street Railway matter,^[43] must be challenged.

256Certainly, as applied to water-works valuation, Mr. Riggs' statement is not justified. The Maine cases clearly include going value as an element of value on which rates should be predicated; by inference, so does the Kansas City case. In the Knoxville case it was in fact allowed by the Master.

In equity it cannot be doubted that going value should be included in the base on which the returns are predicated, if, as contended, it involves real cost to the company; for the company must be permitted to earn a fair return on this cost, or to liquidate it in some way, as otherwise the corporation would suffer substantial property loss—from 10 to 20%, more or less, of the reproduction cost of its property. This would be contrary to public policy, for, with such an outlook, capital would not enter this field of enterprise, except at increased rates of return, commensurate with this added hazard. To assume such increased rates of return is to provide another means of liquidating such a loss.

As to "good will," it has seemed to the writer more proper to use this term in private competitive corporation enterprises, as applied to the element of value corresponding to the going value of the quasi-municipal or public service corporation enterprises, which latter are in effect controlled monopolies. If the term is used in its more colloquial sense, such as the effect on earnings of having, in the office of the corporation, men who meet the public pleasantly, who are good "mixers," and who are active in getting business, the value is substantially included in the consideration of the income, in the manner involved by going value determination and franchise valuation.

The depreciation question has been discussed so fully elsewhere that the writer only calls attention to the fact that, while physical and functional depreciation only are to be considered in a review of the present physical condition of any plant, in considering a fair-rate schedule, provision should also be made for contingent depreciation, covering such items as cost incident to change in street grades or construction of subways; placing structures under ground, which were previously above ground; serious loss due to injury by electrolysis, the distribution of which over a period of years rather than inclusion in the operating cost for one year, is to be preferred, alike from the public and from the corporate point of view, from the fact that it spreads the burden to be borne by the rates, and prevents violent fluctuation in prices or valuation of the public service corporation's property. The public pays dearly for all hazards. It is wise, therefore, to pursue the conservative course in providing adequate funds to meet extraordinary conditions, and to give stability to the investment of the corporation. Moreover, such funds can be carried in a separate account which can readily be watched; any excess can be credited to future reduction in depreciation account requirements, while a prolonged deficit cannot 257perhaps be recovered by the corporation, in the light of the Knoxville decision.

The comment that no hard-and-fast rule can cover determination of proper depreciation allowances, is amply justified. In its final analysis, it is a matter of good judgment, experience, and judicial temper.

The author's statement that the organization, legal, engineering, administration, and general expense accounts, "should not be considered as affected by depreciation, as long as the property is a going concern," is not quite clear. Obviously, this is true with regard to all the early organization expenses, as these expenses are incurred once for all, and constitute a continuing asset similar to other elements of plant cost. If, however, the author refers therein also to the engineering and contingent item added to many of the reproduction cost items making up the physical property, exception must be made; for when an old structure, the life of which is gone, is replaced with a new structure, new engineering costs are incurred, and the engineering element of cost incident to the installation of the original structure no longer inheres in the plant. It, too, has passed away with the life of the structure, and, therefore, its cost should be liquidated, or provided for in the depreciation account, as well as the cost of the structure to which it was incident.

In the same way the "interest-during-construction" item is not a continuing asset, but should be liquidated with the complete depreciation of the portion of the structure to which it relates. The replacement of the structure will involve new "interest-during-construction" charges, commensurate with the time required for construction. The value of the initial "interest-during-construction" costs will have disappeared with the original structure and, therefore, should be taken care of by the depreciation account.

The method of making allowances for interest during construction, suggested by the author,^[44] accords closely with that used by Mr. Alvord and the writer in a recent valuation of a large water-works property, in which the "interest-during-construction" charges were limited, and the contributions to depreciation account were begun, at the date on which any workable unit of the property was assumed to be available for service and to begin to earn a return on its investment cost, even though the structure, as a whole, was not assumed to be completed for a considerable period of years thereafter. Thus, for instance, it might be assumed that as soon as the supplying works in a water-works project were in operation, the investment in them and in the distribution pipe system laid up to that time, would cease to be credited further with "interest-during-construction" allowances, and would be compelled to earn interest through the water rates or income from 258water supplied to consumers—the fact that the interest charge could not be wholly met, immediately at this time, being taken care of in the resulting increment in going value.

Such a theory, of course, does involve a determination of the probable order and rapidity of construction of the component parts of the property, and this is usually made, in water-works valuation, in the estimate of the reproduction cost of the property.

For the sake of completeness, in reference to the legal decisions of importance in valuation proceedings, attention is called to the Pennsylvania case, Brymer vs. Butler Water Company (179 Pa., 231), referred to in the closing discussion on the writer's paper on "Water-Works Valuation."^[45]

In this case Justice Williams, speaking for the Supreme Court of Pennsylvania, says:

"By what rule is the Court to determine what is reasonable and what is oppressive? Ordinarily, that is a reasonable charge or system of charges which yields a fair return upon the investment. Fixed charges and costs of maintenance and operation must first be provided for. Then the interests of the owners of the property are to be considered. They are entitled to a rate of return, if their property will earn it, not less than the legal rate of interest; and a system of charges that yields no more income than is fairly required to maintain the plant, pay fixed charges and operating expenses, provide a suitable sinking fund for the payment of debts, and pay a fair profit to the owners of the property cannot be said to be unreasonable."

The Pennsylvania Court, therefore, in the words of William S. Wallace, Esq., recognizes the single standard:

"The Single Standard, according to the Brymer case, while acknowledging the full right of the public to regulate such public corporations, also recognizes as a prime factor its private character and the rights which accrue to it in that capacity, ... and holds to what seems to me the only rational and practicable basis, that a fair return, after deducting the charges above enumerated, is a reasonable rate"; whereas, "the Double Standard basis of fixing a reasonable rate seems to accentuate the public side of the corporation and rather ignores the private element."

As to the propriety of the inclusion of a substantial recognition of franchise value as a basis for rating, the layman may well confess to perplexity, in the light of the conflicting nature of the two important recent United States Supreme Court opinions referred to—the Knoxville case, and the Consolidated Gas Company case—for, while substantial allowance was made for franchise value, in the Consolidated Gas Company case decision, in large measure apparently on account of its earlier recognition by the legislature, in the Knoxville case, in spite of legislative recognition of such value, and similar approval of 259the issue of securities predicated on such recognition, the United States Supreme Court failed to make similar allowance for franchise value.

The author's treatment of the unit price question and the contingency item is intelligent and creditable. Engineers are prone to make valuations based on "hindsight" instead of "foresight," on the assumption that no substantial difficulties in construction were encountered, when, in fact, substantial difficulties should perhaps have been anticipated, and may actually have been encountered in the original construction, record of them having been obliterated, however, with the lapse of time.

The author's definition of the value of a property, as the "estimated worth at a given time, measured in money, taking into account all the elements which add to its usefulness or desirability as a business or profit-earning proposition," suggests the advisability of recognizing the other side of the ledger by modifying his statement so as to read: "* * * all the elements which add to, 'limit, or detract from' its usefulness or desirability as a business or profit-earning proposition."

While recognizing the author's view, that there is no separate and independent method of determining franchise value, which is not based on the determination of the value of the property as a whole, by capitalization methods, it must be recognized that going value may be determined independently, and may have a positive value, even though the property as a commercial whole is worth less than the sum of the physical value and the going value.

The Court, appraisers, and the author, alike recognize that there is no one method of valuation of universal application. First cost, reproduction cost, reproduction cost less depreciation, commercial value determined by capitalization, worth of the service to the consumer, and market price of the property, if such exists, all have their weight, in varying degree in different cases. Whatever may be said of, for, or against, these several methods of valuation, relates rather to their significance, and the weight which should attach to the results obtained by them, as evidence of value and of the effect of the modifying local conditions, than to the soundness of the methods themselves.

In this connection it may be of interest to refer to a recent valuation of a water-works property, in the appraisal of which the writer chanced to participate, in which there was finally placed before the board of appraisal a summing up of:

1. The original cost;

2. Reproduction cost less accrued depreciation, plus going value;

3. The worth of the service to the consumers, based on a stated assumption of reasonable increment in value in excess of actual cost, upon which a return (or interest and profit) should be earned;

2604. The commercial or capitalized value, on certain assumptions based on present conditions, and also on possible future conditions which might be involved in a renewal of the City contract, which was to expire within two years.

That these determinations of value, from different points of view, had an influence in moulding the opinion of the individual appraisers, there can be little doubt; yet it is probably equally true that in no case was like weight attached to the several items or bases of valuation. Nevertheless, in the final valuation, the consensus of opinion as to the value of the property, as a whole, was remarkably close, the extreme variations in opinion being approximately 8%, more, or less, than the final appraised valuation.

Attention should also be called to the necessity, in any valuation by capitalization of income, such as that outlined by Mr. Riggs and used by Professor Adams in the U. S. Government Valuation of Railroads,^[46] of determining whether the plant or property is in what might be termed an over-built, normally developed, or under-built condition; in short, whether the investing public has correctly gauged its momentary physical condition with reference to its bearing on the rates, and whether the earnings are in fact inadequate, commensurate with the service rendered, or excessive. In the long run, due weight will be given to these facts; in a brief period, they may be incorrectly gauged. In water-works properties, unfortunately, there is rarely, if ever, a market price of the securities which can be said to be credible or significant in valuation. Therefore, in the valuation of water-works properties, it is the more important that the appraisers should weigh carefully the present character of the service furnished and the momentary adequacy or inadequacy of the rates as predicated on such service, on the needs of the community, and the existing standards of the day, if full justice is to be done.

In conclusion, the writer reiterates his statement, that he has taken issue with the author in no carping spirit of criticism, but with a recognition of the difficulty and complexity of the work of appraisal, and the conviction that engineers are under a moral obligation to do an educational work in pointedly calling attention to the fact that the going, or going concern, value, of a public service corporation's property is not an intangible value representing an unearned increment, but a very real and substantial item of cost in the property as a whole. While the difficulty may be met by placing going value, as suggested by the writer, in a middle class between physical plant and intangible values, the placing of it in the same class with franchise and other intangible elements of value, as suggested by the author, may, in the judgment of the writer, do a serious injury to corporations, in failing to give expression, in such a manner as shall be clearly within the 261grasp of the popular mind, to the fundamental idea of the cost of developing going value. While the writer has no personal interest in the matter, on one side or the other, having served both municipality and corporation in water-works valuations, he feels, nevertheless, that engineers can do a genuine service, alike to the public and to the public service corporation, in laying stress on the fundamental elements of cost and value, and particularly those on which rates should be predicated, in public service corporation property valuation and rating.

Charles Hansel, M. Am. Soc. C. E.—So much has been said on the subject of valuation of public utilities that, although the speaker has thought on the subject for ten years, and has done considerable valuation of railroad properties, he finds that he is considerably confused, for the reason that the discussions seem to cover the whole field of engineering, accounting, taxation, and economics; therefore he suggests that, in order to get down to a basis of usefulness, a special committee should be appointed to take this question under consideration.

The speaker had the honor of being associated with the Michigan Commission, as a member of the Board of Review. Professor M. E. Cooley was selected by the State of Michigan to take charge of the work of organization, and Mr. Riggs was the engineer who organized the office and field forces. Both these gentlemen were eminently successful in that very difficult work. Mr. Cooley did this Board the honor of saying that there were so many problems coming up in actually carrying out the work (aside from the theories of taxation, rate-making, accounting, and several other things, which could be found more readily in the Auditor's office than in the Engineer's), that he had asked for the appointment of this Board of Review, to sit as a Court, and to pass on the many complex questions arising from day to day; and he had the satisfaction of coming to the Board every day and saying: "Well, now here is a condition, and how will I handle it?" Of course, actually, he knew more about it than the Board, but he was kind enough to say that he would ask for the Board's opinion. That Board adjudicated all these various questions to the best of its ability, and the speaker has the satisfaction of knowing that the valuation has stood in the Federal Courts. The subjects are so fugitive and so illusive that very much depends on the point of view.

The speaker is now engaged in the actual task of trying to place a valuation on some $300,000,000 worth of property in New Jersey, involving the most important terminals in the United States.

The valuation of public service utilities is the most profound question which has ever been before the Society, and it includes a great deal which is outside of strictly engineering questions; in fact, the discussions do not throw much light on the methods which should be followed in making valuations.

262The terminology of a subject is very important; in fact, the speaker has found it so important that in his discussions with the Attorney-General of New Jersey, in reference to the Railroad Tax Law, which he has been asked to re-draft, that draft will be accompanied by a glossary, so that the meaning of certain terms used in that particular Act will be clear.

In this New Jersey work some eighty-seven engineers and assistants are employed, and for their guidance the speaker has prepared thirty-five pages of very carefully considered instructions. These instructions are accompanied by blue prints showing exactly how all field notes must be recorded, with diagrams of trusses, culverts, and the like, and all the elements of railroad construction.

The Tax Law of New Jersey states that, first, the true value of the real estate shall be ascertained; second, the true value of the tangible personal property; and the first law of 1884 stated: "and third, the value of the franchise"; but somebody discovered that there was something besides the value of the real estate, the tangible personal property, and the franchise. They did not know what it was, but there was something else; therefore, in the 1888 law they changed the third division of value to read: "the remaining property, including the franchise."

As an example of one of the difficulties of determining classification, attention is directed to the term, Real Estate, which is broadly, but seldom accurately, understood.

The Interstate Commerce Commission is the highest tribunal in the land, in the matter of railroad accounting, but it affords no help in many important elements of value; for instance, under the Interstate Commerce Commission, real estate includes only such real estate (land) as is not required for railroad purposes. All land actually used for railroad purposes is classified under "Right of Way and Station Grounds."

When the engineers on the New Jersey valuation were sent into the field, it was necessary to specify exactly what elements must be described as real estate, and what as tangible personal property. The division line had to be defined accurately for the reason that all personal property is assessed permanently to the State, while, in the case of real estate, the State receives the taxes on a strip not exceeding 100 ft. in width, and the tax on all property used for railroad purposes outside this strip reverts to the taxing district wherein it is found.

The vexatious question as to whether machinery is to be considered as real estate or personal property was settled by the New Jersey Law, which says that tangible personal property shall include all machinery; but it left unsettled the question: what is machinery? After careful consideration, real estate was divided into 74 classes, and all other tangible elements were classified as personal property. Some of the items of 263real estate are: ash-handling machinery and the like, chimneys, cisterns, conveyors, dams, locks, lock machinery, electric wiring, piping, heating, interlocking, signaling, pavements, reservoirs, shop fittings, tanks, telegraph lines, track, track scales, transfer tables, water-works, etc., etc. Generally speaking, all items of a fixed character were included in the 74 divisions of real estate.

The difficulties of determining all the elements of real estate are mentioned simply to call attention to what at first glance seems quite simple, but on close examination is found to have great complexities.

The question of useful life depreciation, direct and indirect, due to decrepitude or obsolescence, or both, is one of the illusive questions; and then comes the value of the franchise.

The valuation of railroad property in New Jersey is further complicated by the requirements of the State Tax Law, which specifies that the value of the remaining property, including the franchise, shall be determined after the "true value" of the real estate and tangible personal property have been determined.

The speaker will not attempt a discussion of franchise values, as it is a subject which requires the most profound study.

The author states that he is appalled at the speaker's misconception of the method of determining non-physical value used by Professor Adams in Michigan. The speaker is perfectly familiar with that method, and, although having the greatest respect for Professor Adams' opinions, is compelled to draw attention to two important elements of that formula which are open to objection.

Professor Adams establishes his annuity on the depreciated value, rather than on the cost, or the reproduction cost, which, in the speaker's opinion, does not determine the proper annuity or reasonable fixed charges to be deducted from net income before net surplus is established. Bonds are generally sold at a considerable discount, and represent the full cost plus this discount, consequently, the interest on bonds or fixed charges will be greater than an annuity established on cost, "reproduction cost," or "present value." Would it not more nearly establish fixed charges or annuity, to take the cost plus discount and commissions as the basis on which to apply the annuity rate?

While Professor Adams' formula establishes a larger net surplus for capitalization than the method suggested by the speaker, he in effect destroys this net surplus by charging against it all betterments chargeable to income. It is quite clear that this gives the railroad company a chance to absorb all net income into betterments, and thus wipe out all net income, in which case there would be no net surplus to capitalize, consequently, no non-physical or franchise value, and the total value established under this plan would be less than if the property had not been improved by the betterments—reductio ad absurdum.

264In reference to the question of whether or not the method of valuation should be the same, regardless of the purpose to which the value is to be applied, the speaker cannot agree with the author, and believes that it is quite consistent to establish different values for different purposes.

The completion of a large public utility, planned on such a scale as to provide for the requirements of many years to come, utilizing but part of its capacity, and earning less than its operating expenses and fixed charges, with its rates of toll fixed by law, must be considered in a different way than a well-established public utility, with business forcing it to its utmost capacity, and with tolls not fixed by law. There are many important elements bearing on this consideration of value, and the purpose of the valuation should be known before attempting to establish the value.

In New Jersey the work is complicated further by the necessity of establishing the value of 122 separate railroad corporations, and the assignment of all property outside the 100-ft. strip to each of the 450 taxing districts through which the 122 corporations, with their many branches and spurs, are operating.

In order to determine the quantities and materials in the permanent way and structures, nine engineer corps were organized, each corp consisting of six men. With this force the center line of the main running track was measured, and the exact distance in each taxing district recorded. Cross-sections of the roadbed were made as often as changes in the natural surface required, and accurate measurements and notes were made of all structures; and, although in many cases the engineers were able to secure the plans of the more important steel structures, the field parties were required to obtain sufficient data to compute the tonnage in case it was impossible to get these plans.

The field parties were also instructed to note the character of the land and improvements adjoining railroad property, and record such other information as was necessary for a comprehensive understanding of the conditions attendant on the construction of a railroad in that locality.

The time allotted for the completion of the work is one year, and although this is a comparatively short period in which to introduce a premium system in field work, it was decided to inaugurate such a system as would be as nearly satisfactory as possible under the conditions. A record of each field force for each day in each month was made on profile paper, using the horizontal lines to represent the number of tracks, and the vertical lines to represent distance. Two horizontal lines were allowed for single track, four for double track, and so on. One mile was allowed for each vertical division of the paper, and, in awarding the premium, there was taken into consideration, 265not only the extent of territory covered by each field party, but much consideration was given to the field notes, and a cash prize was awarded each month.

The results of the organization and encouragement to the field parties are shown by the very great increase in the amount of work per man of the field parties, which was nearly 300% during the time the parties were in the field.

A great many questions hinging on interstate commerce, and involving Fundamental, State, Federal, and International Law, are embraced in the broad view of the valuation of railroad properties. The movement of rolling stock through various States, and between the United States, Canada, and Mexico, and the determination of the situs and domicile of floating equipment, are subjects which, not only require considerable knowledge of railroad operation, but involve many questions not clearly determined by the Courts.

The subject is of such great importance that steps should be taken to formulate methods of procedure, and, at the Annual Meeting of the Society, the speaker will offer a resolution requesting the appointment of a Special Committee to determine the proper methods to be used in the valuation of public utilities.

J. Martin Schreiber, M. Am. Soc. C. E.—Engineers and those generally interested in the valuation of public service properties are fortunate in having the valuable information embodied in this paper. Although there are some points on which the speaker differs with the author, the following remarks are only offered in order to bring out, from experience, some further phases of the subject, rather than as an attempt to criticize.

A great deal is heard about the exact cost of reproduction, also arguments in reference to the proper allowance for contingencies, probably only involving a small percentage. The speaker questions the propriety of advocating the exact cost figures. The carefully checked cost figures of reliable contractors, with first-class engineering organizations, submitting proposals on the same construction, are often found to vary from 5 to 15% from the total cost. Different organizations will sometimes be the cause of figures varying 5% or more, depending on the efficiency and experience of the corps. A clever purchasing agent will reduce an apparently precise estimate on equipment or supplies as much as 10%; on the other hand, the condition of the market may be such that the actual price paid exceeds the estimate by the same percentage. Engineers who are responsible for estimating on, and the execution of, construction projects generally add more than 10% for contingencies, as it is practically impossible to anticipate them, and a precise estimate is almost certain to fall short. It is unfortunate that it is almost impossible to sustain contingency 266figures on the witness stand; for that reason, probably, it would be more satisfactory to the lay mind, and to the various courts, boards, etc., which are required to pass on valuations, and do not thoroughly understand the technicalities of the situation, if engineers would drop the contingency item and modify the quantities or the unit prices.

If it is possible to estimate the exact cost of reproduction, certainly considerable variation may be expected from independent sources in computing depreciation and present values. Yet there are reputable engineers who would have one believe (assuming that they know the cost of reproduction) that by a simple field inspection they are able to compute the exact present value.

Some time ago, the speaker heard an expert testify in the interest of a certain city, for tax purposes, with reference to the value of a piece of street-railway track. He first stated the valuation for reproduction, and then the definite present value. The latter was greatly in excess of the actual value. The expert, who was an engineer of considerable standing, on cross-examination, did not know the height of rail from top of head to bottom of groove, either at the joint or any other part in its length; he did not know the exact depth of flange of the car wheels which operated over that track, the headway, or the exact weight of the cars used. He had assumed the condition of the ties, and that the track was ballasted. Finally, he was compelled to admit that his determination of the depreciation, by simply a field inspection, was a very rough approximation. Now, it is not in every case in the past that a corporation attorney, even with engineering assistance, has been able to point out unfair testimony. Many times the speaker has heard incompetent testimony admitted, on the general principle that the witness was an engineer of note, even though his record had been made in other specialities. Too much stress cannot be put on this phase of the subject, and the speaker is glad that the author has mentioned the fact that the personnel of those doing appraisal work should be of the highest order. In the past it is probable that the failure to discriminate properly in accepting incompetent testimony (not to mention prejudiced testimony) was automatic, and this is the most important reason for much of the hostility of officials of public service properties toward all forms of investigation, as the author mentions.

Company officials know that they are often compelled to employ and train specialists to furnish, within fairly accurate limits, the very information which is being sought, and naturally they are skeptical about the data presented by those who, though not intimate with the property, purport to give exact cost figures. Any one who is able to point out a consistent method whereby these exact figures may be obtained surely will obtain credit for a valuable contribution toward the solution of the complex subject of valuation.

267Referring to the valuation of the property of the Detroit United Railroads, mentioned in the paper, the Director of Appraisals for the city estimated that the cost of the complete appraisal of the property, which includes about 220 miles of single track, would be from $3,000 to $4,000. Approximately, $25,000 has already been spent, not including the expense sustained by the company, which furnished a large proportion of the information.

Probably correct present value estimates which include depreciation may not be even fairly approximated without intimate knowledge of the particular property, and this should embody operation, policy of management, past performance, study of historical cost (as far as the records will permit), estimated cost of construction, and actual cost of maintenance. The life of a piece of track or equipment, disregarding obsolescence and extraordinaries, generally depends on the type and details of construction, the service it has done, and the service that will be required of it. Renewals should be made when the cost of repairs reaches a certain figure, other conditions being favorable. It is a fact that able engineers, intimately acquainted with the case at issue, and employed on the same property, often have conflicting ideas in reference to the life of track or equipment, one recommending immediate renewal and another advocating longer operation.

The speaker does not intend to argue against the possibility of placing fairly accurate values on reproduction or present value, but wishes to bring out the fact that it is not as simple as the lay mind is often led to believe. Further than that, he is of the opinion that the following is essential for economical and satisfactory valuations for all concerned:

(1) There should be co-operation of the appraisers with the public service property officials, including operators, engineers, and their records.

(2) Present values should be determined by:

(a) Cost of reproduction,

(b) Mortality tables,

(c) Data of performance,

(d) Field examination.

(3) The organization for the appraisal work should be of sufficient scope, and should be allowed the time and funds which the project reasonably requires.

(4) The appraisers should be carefully selected, the personnel including men who have had wide experience in the particular class of operation; and specialists should be obtained if necessary.

Mr. Riggs states that the valuation should be the same, regardless of the principles at issue. It seems questionable to consider the fair value which involves the non-physical value in costs or tax regulations. 268Certainly, in the case of street railways in cities, where a percentage is levied on the gross receipts, the non-physical valuation, only representing present value, is necessary. Again, a physical present value for taxation should not include the value of paving in the street in the strip occupied by street-railway tracks. That the street-railway company often pays an arbitrary assessment tax and keeps the paving in repair, though it is in no way responsible for the wear, should be sufficient to offset any obligation for other taxes. In some States this is fixed by the Courts. The physical valuation, however, intended to be used in connection with rates, cost, or capital regulation, should include the cost of paving the railway strip. Referring further to the question of including the paving in the physical valuation of street railways, in the case of a decision of R. W. Tayler, Arbitrator, in the proceedings between the Cleveland Electric Railway Company and the City of Cleveland, on a basis of a renewal of franchises, Judge Tayler said:

"Paving represents actual money expended. It belongs to capital account, and in its depreciated form is worth all the allowance that I have given it."

Also for rate-making and the capital regulation some consideration is certainly due to obsolescence and change of art, while in taxation they should not be included.

In conclusion, the speaker is optimistic enough to believe that the problem of physical valuations will be solved satisfactorily for all concerned. Co-operation of officials of the public service properties, reliable testimony, with a better understanding by the Courts, will certainly tend to clarify the situation. Non-physical values are very difficult to determine, and their intelligent treatment will require some well-defined procedure. Mr. Riggs' valuable paper will go a great way toward producing a correct idea of the general proportion, and will, no doubt, assist in the formulation of proper methods for valuation.

Clinton S. Burns, M. Am. Soc. C. E. (by letter).—The author is to be congratulated on the detailed care shown in the presentation of this subject. Perhaps few engineers who have not been called on to cope with the subject of valuation of properties, realize or appreciate the real complexity of the many varied problems encountered in work of this class. To those who are engaged directly in appraisement work, this paper will be a welcome contribution to the literature on the subject.

The author's statement that if a commission of engineers is directed to report the true cost of reproduction, depreciation, or present value of a certain property, the final figures should not differ, whether the report is to be used as a basis for reorganization, sale, rate purposes, or taxation, is open to argument. It seems proper that, if a property is appraised in order to fix a selling price to a Government or municipality 269exercising its right to purchase, the final figures should be based on current prices of labor and material, because this does no injustice to either party. It is evident that if the seller secures payment for his property based on current prices, he may, if he desires, reinvest the proceeds of the sale in similar enterprises at current prices, so that thereby he secures the same benefits, whether prices are high or low.

It is equally evident that if the purchaser (the municipality) chooses to purchase the property, the right to purchase must be exercised at the particular time permitted by the franchise. If prices chance to be abnormally high at that time, the municipality is exactly on a par with what it would be if compelled to build its own plant at that particular time; while, if prices be abnormally low, the same relative situation still exists. There seems, therefore, to be no possible injustice to either party in using current prices, when the object is a sale or transfer of the property. However, in determining a proper value as a basis of rates, another factor must be considered. It is inexpedient and against public policy to make frequent changes in the rate charged for such commodities as water, gas, or electric current. Theoretically, the rate could be fixed each year, based on an annual valuation of the property, thus permitting a high rate one year and perhaps an abnormally low rate another year; but, practically, this is impossible, for, aside from the inconvenience of such a cumbersome system, no community is well enough informed as individuals to comprehend any reason whatever for ever raising rates. Raising rates is invariably accompanied by a wave of indignation. However, it is apparent that a series of rates based on an annual current price valuation of the property would average exactly the same, during a term of years, as though the property were valued once for all on the basis of the average prices of labor and material for the same term of years, and the rate based on the one valuation thus determined.

If the object of the valuation is to afford data for taxation, the same argument applies as in a case of fixing rates. It thus seems proper that the object of the appraisement should be taken into consideration before it is determined whether to use average prices, or current prices, of material and labor; and, if this is correct logic, the final figures must differ according to the object in view; but, having determined the proper unit prices to be used throughout any appraisement as being the most equitable for the object in view, then, as the author well says, the appraiser must not allow personal prejudices or fancied conditions to influence his course. Above all, an appraiser must not be afraid of his client. He must not allow his personal judgment to be swerved by the latter's desires. It perhaps seldom if ever occurs that an appraiser, representing a municipality, or State, is subjected to this unconscious influence, inasmuch as his employer 270is merely a temporary public official, and consequently he has no client to fear. He goes into the work with a full knowledge that his employer knows little or nothing of the subject, and his only desire is to reach results which will be unquestionably fair to both parties.

On the other hand, the appraiser who is chosen by the owner of a plant takes hold of the work with a feeling that he is expected to report a value as favorable as possible to his client, and this feeling is reflected in the report, regardless of how sincerely or conscientiously he tries to avoid it.

One of the most intricate and yet interesting problems in appraisement work is the computation of the "going value," or "business value" which should be allowed in addition to the physical value.

In considering a competitive enterprise, such as a railway serving a community in competition with another independent railway, this problem must be treated in a different way than in a non-competitive business, such as a water-works, gas-works, electric plant, street railway, or similar enterprise operating under the protection of an exclusive franchise, or under natural conditions equivalent to an exclusive privilege.

In considering competitive enterprises, it is manifest that a railway operating under conditions more advantageous than its competitor possesses an intangible value equal to the measure of that advantage. It is not clear, however, whether it is more proper to say that the railway possessing the advantage has a positive going value, or whether the less fortunate one has a negative going value. Using the rule formulated by the author, being that of Professor Adams, with some modifications, it is evident that many properties would show negative going values; but, as pointed out by the author, the Courts hold that public service corporations are entitled to earn:

(a) Operating expenses;

(b) Expenses of maintenance and running repair;

(c) Taxes;

(d) A sinking fund to cover depreciation and obsolescence;

(e) A reasonable profit on the fair value of the property.

It is improbable that a reasonable profit on the fair value of the property could be construed to mean less than the interest or revenue from a like amount of Government bonds or other non-taxable securities.

This ruling of the Courts fixes the rates at such a figure as to preclude the possibility of a deficit; from which it must follow that a negative going value cannot be created by a compulsory reduction in rates, for such action would be confiscation of property to the extent of the negative intangible value thus created; that is to say, if the Courts are right in the above ruling, then all intangible or going values 271are positive, and must be determined by using the most unfavorably situated railway as the basis of computation in determining the question of reasonableness of rates; and the rates in turn must be reasonable and proper before they can be applied to determine the intangible value. This raises an interesting and far-reaching query. Assume that a negative going value is the result of real competition between two roads such that the "fair value" of the less fortunate competitor is 20% less than its physical value.

If rates are based on this valuation, are they really fair rates? For, suppose the rates had always been maintained at a point where the less fortunate road could just support its physical valuation. Clearly, no rate could then be enforced which would compel it to operate for less than a reasonable profit on the fair value of its property, and the fair value under this assumption is 25% greater than before, due to no effort of its own, but simply to the fact that its competitor has not cut rates, and has thereby preserved the original "fair value" of the less fortunate road, and at the same time increased its own positive going value by an equal amount.

In view of this analysis it is doubtful if it is ever proper to consider the existence of negative intangible values, although it is true that the commercial value does fluctuate, and may be less than the physical value, due to rates which are too low, perhaps, or due to other temporary causes.

The method quoted from Mr. Alvord for determining going value applies to non-competitive enterprises only, as was stated by Mr. Alvord in his paper before the American Water-Works Association. This method is open to the criticism that the forecast of the business of the older works, and of the new hypothetical works as well, is reduced to a monetary value, based on the present rates, regardless of whether or not such rates are reasonable. Rates are subject to legislative control in many States, and there is absolutely no assurance that any other State may not adopt legislation at any time permitting regulatory ordinances to be enforced. Therefore, any forecast of the value of future business must be based on reasonable rates, for otherwise it is merely an unwarranted estimate based on a fond hope.

Taking into consideration the fact that rates must be reasonable, either by virtue of present laws or laws which may become effective at any time, perhaps in the immediate future, going value may well be defined as the present worth of the amount by which the anticipated profits of a going plant, operating at reasonable rates, exceed the present worth of the anticipated profits of a similar hypothetical starting plant, operating at those same rates. With this conception of going value, it is impossible for a non-competitive property to have a negative going value, and every operating plant has a positive going value, even though operating at a loss.

272The whole problem hinges on the question of "what is the reasonable rate or proper return," and this should be determined in the aggregate as the starting point. The Courts have persistently dodged the issue, and properly so, whenever that question has arisen, leaving it for consideration in each particular case, depending on the stability of the business, the hazard involved, and various other local factors.

It may safely be conceded that this fair profit is something in excess of the return from Government bonds, and for the purpose of this discussion it matters not what figure is assumed as the fair profit—whether 5, 6, or 10%, or what-not—the theory is the same in any case. This is perhaps best explained by a practical illustration:

Take, for example, a water-works system, the physical present value of which has been determined by the method of reproduction to be $1,000,000, and denote the going value by the unknown quantity, x; suppose, further, that 6% is considered a reasonable return on the "fair value"—not yet determined, the "fair value" being $1,000,000 plus the going value, x. Therefore, the rates must be such as to produce in the aggregate an amount equal to the operating expenses, maintenance, taxes, sinking fund, and depreciation, and still have a profit of 6% on the fair value of the property. The anticipated profits of the going plant, therefore, are exactly 6% of ($1,000,000 + x) = $60,000 + 6x/100 per annum. The anticipated profits of the hypothetical starting plant will be negative at the start, and gradually increase, finally reaching a maximum of $60,000 + 6x/100 per annum.

It must be remembered that, in estimating the operating expense and income of the starting plant, as well as the going plant, the figures must be confined rigidly to the plant as it is found at the date of valuation, and in no case should any account be taken of income or operating expenses due to probable future extensions of the distribution system. Many appraisers overlook this point, and predicate the anticipated profits of the going plant on the past growth of the income account, forgetting that a considerable portion of this growth is due to extensions into new territory, and not to any material increase in revenue from the territory already served. To include income from new territory in the forecast of income is just as fatal an error as to include the anticipated expenditure of new capital in the present physical valuation. Either of these procedures is really an estimate or appraisement of some other plant, rather than the one actually under consideration.

To complete the numerical illustration, suppose it is determined that the time required to construct the hypothetical starting plant is 3 years; that a portion of the plant is put into operation at the end of the second year, taking over fire-hydrant rental equivalent to $20,000; 273that the revenue from private sources aggregates $20,000 during the last year of construction; that the expenses of operation, maintenance, taxes, and depreciation amount to $30,000 during this year. After the time of completion of the plant has elapsed, it has the total credit for fire-hydrant rental, and it is assumed that the revenue from private sources and the cost of operation, maintenance, taxes, and depreciation increase as shown in Table 14, which illustrates the method of computing the going value, and gives the resulting value for the case just stated.

Therefore, 171,005 + 0.2597x = x; hence, x = $231,000. This result is based on the assumption that the starting plant earned no interest during the construction period. If an allowance for lost interest during construction has been made and added to the capital account already being included in the physical appraisement of $1,000,000, then this must be charged back against the going value found above. This is clearly evident, because the calculations to determine going value date from the beginning of the construction period, and the lost interest during construction, therefore, is provided for in the result. Most appraisers allow an item for lost interest amounting to the legal rate of interest running for half the construction period, which, in the illustration under discussion, would be $90,000; deducting this sum, if previously included, gives $141,000 as the going value.