Physical Values and Methods for Their Determination.

All the foregoing narrative of methods adopted in recent valuations, review of judicial opinions, and comment on the expressed opinions of various engineers and railway officials, is presented as being proper and necessary to support the contention that the Michigan 129valuation, while not the first appraisal work, was the first valuation work of large magnitude undertaken by any State; that it was a work which established many precedents; and that the complete discussion of methods and principles in connection with and following this appraisal has given it probably a greater general value than any similar undertaking. The Wisconsin work, which immediately followed that of Michigan, was along lines similar to those of the Michigan physical valuation, and carried the work forward, adding to and strengthening certain of its features. Without any impropriety, it may be claimed that these two appraisals have laid down the general lines on which this class of engineering effort will be largely directed in the future.

It is desirable, in closing this paper, to indicate such general methods of procedure in valuation practice as may be said to have been thoroughly established by precedent, and to present such argument as will support the contention that such methods are proper.

The fact has been emphasized, again and again, by every writer on the subject, that problems of this class are not capable of exact mathematical solution; that, no matter how much care may be exercised in the execution of the work, the result is tempered by the personal judgment of the men engaged on it, and that only when it is executed by men of experience, sound judgment, and high moral worth can it have a definite, final, and just result.

This feature of appraisal work cannot be too strongly emphasized. The value of the work depends on the character of the men doing it, their experience in design, construction, and operation of properties, and their absolute fairness and freedom from prejudice.

That there will be many large valuations undertaken in the near future, there appears to be no doubt. These valuations will be made as a necessary preliminary to three classes of corporate control: rate-making, taxation, and the regulation of capitalization.

The Courts hold that the value must be "the fair value of the property used for the public," and that the corporation:

"may not impose upon the public the burden of such increased rates as may be required for the purpose of realizing profits upon [such] excessive valuation or fictitious capitalization." (Smyth vs. Ames.)

130This language is repeated, again and again, so that it is clear that any valuation, to be sustained by the Courts, should:

1.—Be based on a careful study and analysis of all the information applicable to the case in hand; and

2.—That it must separate the various elements so that every step of the work may be reviewed and supported.

Public interest demands that, in any valuation, certain figures shall appear which shall show the amount of bona fide capital actually existing in the property at the date of appraisal.

The fact that a given amount of money was invested in building a railroad in 1880, and that certain other sums were spent for additions in subsequent years, does not necessarily indicate that these amounts of capital will still be found in the property in 1910.

The removal of timber from surrounding lands, the destruction of industries and the removal of tracks leading thereto, the destruction of equipment and facilities, the depreciation in value of adjacent property, along with wear and tear, and obsolescence, have gone to effect the destruction or loss of capital on many Michigan railroads. The case in 212 U. S., 1, clearly directs that the valuation must not take into account this destroyed capital, but must return a "fair value of the property as it is."

On the other hand, the amount of money actually spent in producing a given property in the past may be far below the present value. The appreciation of value of lands by reason of development of cities and growth of industries, the increase in cost of the materials entering its construction, and many other causes, may lead to an appreciation of the value of the property, and this appreciation should appear in the valuation and the company be entitled to the benefit of it. It is in the nature of an increase of the investment, and should appear as capital.

It is clear that there are two classes of elements of value in the final value of a public service property: those which are physical, and those which are intangible. There are various of the physical elements of value which are not material or susceptible of inventory, but which, nevertheless, attach themselves to the physical property, are capable of determination, within reasonable limits of certainty, and should be taken into account and computed as physical property.

In the subsequent discussion of physical and intangible values, it is 131attempted to differentiate between such elements as should attach to the physical value, or capital remaining in the plant, and the purely intangible or franchise values.

It is contended by the writer:

That the Physical Value, or present value of the physical property, should fairly represent the actual capital invested in the property at the date of appraisal; that it should be made up of the sum of the various elements which constitute the cost of reproducing the property together with any appreciation which may have been added to any of them, less all depreciation.

That the Non-Physical Value is the difference between the "fair value" as defined by the Courts, or the reasonable value of the property as a business or producing property, and the physical value, or actual present worth; and that the only proper method for determining such values involves a study of income accounts.

This Non-Physical Value may be: positive, or a value in excess of the physical property, or negative, or less than the physical value. In the case of a property having a negative intangible value, a deduction should be made from the physical value.

It is further contended that, in making the physical appraisal, the purpose of the appraisal should not be permitted to modify the figures. The resultant figure should be the same, whether it is to be used as a basis for assessment, rate-making, or limitation of capitalization. It should be an engineering estimate of the amount of bona fide capital still remaining in the property, or of the complete cost of reproduction under existing conditions, less depreciation. This figure is definite, within reasonable limits, and it cannot be conceded that it is permissible to vary it, submitting one result as a physical value for taxation, and another and different result as a present physical valuation for rate-making.

There may be some question as to the propriety of using non-physical values for certain ultimate ends; in fact, the Supreme Court, in the Omaha and Knoxville water cases, clearly indicates that they must not be used for certain purposes; but, in any case, to furnish information, this element of value should be determined, and, as in the case of physical values, it should be an unchangeable figure^[18] and should represent the difference between the worth of the actual physical property and the final business value of the property considered as an earning proposition.

132It is not necessary to go minutely into detail as to the various steps to be taken in making the appraisal of physical property. Each appraisal will offer some problems peculiar to itself, and no general set of rules can be laid down which will be applicable to all cases. It is deemed sufficient to call attention to general matters of major importance and to refer to some points which have not been mentioned in the preceding narrative, omitting argument in the case of such as have there been fully discussed.

The distinction should be kept in mind that any element of value which belongs to the property by reason of its physical existence is classed as an element of physical value. The property is considered as an operating property in the sense that it is reproduced complete, ready to operate; and any expense, or any element of value needed to complete it, is an element of the physical value, but any value arising as a result of surplus earning power, any good-will value, going-concern value, or value due to established business, strategic location, favorable traffic arrangements, etc., should be considered as intangible values.

The valuation of physical property is naturally divided into four parts:

I.

—The preliminary study,

II.

—The field inspection,

III.

—The computation,

IV.

—The preparation of the final figure.

I.—The Preliminary Study.

The preliminary steps should include a general examination of the property, a study of its corporate history, an examination of its records, maps and profiles, and the preparation of an inventory of its property.

The work in Wisconsin and Minnesota was done in co-operation with the railroad companies, who prepared (generally, but not in every case) their own inventories on forms adopted by the appraiser. In Michigan, all this information was secured by the appraiser. There can certainly be no valid objection to the use of information compiled by the companies, whose familiarity with their own records and property 133would enable them to supply lists which under all ordinary conditions would be more complete and up-to-date than if made up by men having no special knowledge of the property.

The chief difficulty encountered in making an inventory from recorded data lies in the fact that very few sets of records are corrected to date, and many additions and erasures will of necessity have to be made in the field.

In making a field inspection, it is of great assistance to be able to refer to maps of large yards, to profiles, to standard plans, and to drawings of the principal structures, so that the investigation of office records should include a careful examination of the maps of principal terminals, with a view to securing such as will simplify the field inspection. The investigation should be extended to cover a study, not only of the engineering office data, but also statistical data to be derived from the records of the auditor, superintendent, and superintendent of motive power, and should cover earnings, operating expenses, car and locomotive mileage, and such other data as will facilitate the distribution of such elements of value as are not localized, together with such other statistics as will furnish a thorough knowledge of the property and its operations.

It has been claimed by the appraiser in Washington—and the view is also held by the Commissioner of Railroads in Nebraska—that original cost is essential, in view of the Supreme Court's decision, particularly in Smyth vs. Ames. The writer cannot accept the correctness of this position. It would appear that the language of the Court should be construed to mean that original cost, where ascertainable, is a proper matter to take into account, along with many other things; but it can hardly be considered mandatory.

In the case of a property only recently built, in which the records are complete and the engineering and construction files are available, it may not be specially difficult to determine cost, but in the case of any of the large railway systems of the United States, which are made up of the consolidation of many different roads, some of them built many years ago, some of them having gone through many changes of management, reorganization, and earlier consolidation, it is practically impossible to secure either the old financial books or the old construction records, and without these complete records it would appear to be an utter impossibility to secure the primary cost. Primary cost is but 134the first step. The work of building up, by securing the amount of additions and betterments that have been made from year to year, is one of appalling magnitude and of utter uncertainty and conjecture. Keeping in mind that, prior to July 1st, 1907, the railroad companies of the country did not have a system of uniform accounting, and that additions to property were charged to operating expenses to the extent of hundreds of millions of dollars; that policies were different on different roads, and under different managements of the same road, and that the accounting methods were determined by the policy of the road or management; and the further fact that the distribution of ordinary railroad accounts may be extremely reliable on one road and abounding with errors on another; it will be seen that any attempt to depend on the auditor's office for anything approximating a complete statement of cost would lead into a maze of figures which would be confusing, unreliable, and incapable of proof.

Therefore, it is the writer's conclusion that, beyond such figures on recent construction, or records of cost of such special structures as are matters of particular record, it is not advisable to attempt to secure complete data as to the cost to date of a railroad. In the Michigan appraisal, original cost was secured in the case of many structures, notably the Port Huron Tunnel, and it is by no means argued that original cost should not be considered, or investigated, but it is held that such an undertaking as to secure, from the financial books of the company, an accurate or reliable statement of construction cost, plus additions and betterments, less property destroyed, of the Michigan Central Railroad, for example, would be absolutely an impossibility, particularly if the work was to be undertaken, as in the Washington appraisal, by men who were utter strangers to the property. The admission of the appraiser of Washington, that, except for a few gaps, the information was complete, is fatal, as the gaps must needs be filled by estimates, and it would appear to be better to depend on estimated figures throughout than to use what purported to be actual costs on part and estimates on the remainder.

If original cost is essential, it is hard to get away from accepting the book values of the companies, as these, objectionable as they may be, from the viewpoint of the public, are just as apt to be as near the actual truth as any statement made up by strangers from an examination of old records covering many years of operation.

135

II.—The Field Inspection.

The field inspection, to be of the greatest value, should be made by civil or mechanical engineers of long experience, preferably by men who have had charge of their respective departments on railroads of considerable extent, or of properties similar to that under investigation. The writer is of the opinion that in this particular phase of the work, the practice adopted in the Michigan appraisal was considerably in advance of more recent valuations. Each particular structure or piece of equipment should be examined and its condition noted; special features should be fully described and careful record made of everything that would tend to affect the value. The argument has been often made that the fixing of a percentage of depreciation by a man in the field is purely arbitrary and amounts to nothing but a guess. In the computing office it is often necessary to check the field figure of depreciation by the use of tables of fixed annual depreciation, but it must be borne in mind that mortality tables of any form are based on a system of averages. The actual depreciation on rail, for instance, varies greatly; the conditions of traffic, curvature, gradient, rolling stock, and various local conditions tend to shorten or lengthen the life, so that the personal opinion of an experienced man on the ground is likely to be much more nearly correct than the arbitrary application of a rule of averages.

The writer has inspected station buildings more than 50 years old, and their condition and adaptability for the service required of them would give them a very high percentage; he is also familiar with buildings less than 10 years old, which, by reason of changed traffic conditions and consequent shifting of business, have become obsolete and have been permitted to depreciate so rapidly that any table average would give too high a result.

In the case of a water-works inspection, so much of the value is included in the system of distribution mains, a form of property which is inaccessible, that much more dependence must be placed on a figure based on age; but there, also, as full investigation as possible should be made, in order to determine to what extent tuberculation or electrolysis has affected the pipes.

A general inspection (made in Minnesota by the appraiser with two assistants) would appear to be an excellent thing as a review of the whole work, but whether such an inspection would be sufficiently 136thorough to base thereon a set of final values, would appear to be doubtful.

The inspection in the field, in addition to the placing of a percentage for depreciation, should involve a complete check of the inventory, a correction of all errors, due to the construction of new property or the destruction or removal of old, and a compilation of all information required for a complete, correct, and intelligent appraisal of the physical property by the computing office. Every appraisal is different, and every property offers new problems and diverse conditions. These must be met, and therefore the field inspector must call particular attention to all matters specially affecting the values of the property he is inspecting.

It is impossible to anticipate all these conditions in advance, although the use of carefully prepared blanks and the standardizing of the form in which the data are gathered greatly simplify the work, not only in the office, but in the field.

III. The Computation.

On the completion of the field work, with all the preliminary data in the office, the computation must proceed, and with this part of the work there are many questions which must be taken up, considered, and definitely answered.

The classification and arrangement of the information as to the property to be valued, the costs and prices of the various materials entering into construction, the making and checking of such tables as may be required for estimating, the computing, checking, filing, indexing, and the various other routine details of work need not be referred to specially, as they must be worked out for each appraisal. The matters of principle that will be met are more important, and, while it would be impossible to mention all that may come up, it may not be amiss to refer to a few.

(a) In making an appraisal of several properties, to what extent shall these properties be grouped or classified?

(b) What unit prices shall be assigned in the estimates of cost of reproduction, and how shall they be determined?

(c) How shall right-of-way and real estate values be ascertained? Shall such elements as appreciation, or any increments due to the purpose for which the land is used, be treated as physical or non-physical values?

137(d) What method shall be finally adopted in determining depreciation? What elements shall depreciation be made to cover?

(e) What elements of cost or appreciation shall be treated as parts of the physical property although not capable of inventory, and what shall be treated as non-physical?

(f) Is an allowance for contingencies a proper item to include in an appraisal?

(g) What weight shall be given the matters of adaptability, proper or improper design, and the economics of location?

(h) How shall the values of such property as locomotives, cars, etc., be geographically assigned?

(i) What is the effect upon values of large terminals?

(j) Should an allowance be made by reason of rapid development of the art?

These are not by any means all the perplexing questions that arise; each valuation offers some that are special, but these cover the more important points.

(a) Classification of Properties.—In making an appraisal involving the properties of a large number of companies, such for instance as any of the State railroad appraisals, it becomes evident that there are certain properties which are small, badly run down, and either built to serve a very limited trade or located in a territory which has not developed, and that such properties cannot be compared equitably with the large trunk-line roads, or even with smaller roads in a good territory and doing a good business. Several such properties exist in Michigan in a district which was originally a lumber-producing country, and at the time they were built local conditions were such that prices of timber and labor were far below any cost that it would be reasonable to assume to-day. Whether taxation or rate-making be the ultimate end of the work, it is certain that these carriers are entitled to some classification which will separate them from the more prosperous roads. Many of these roads would not be built to-day under any circumstances, yet their maintenance and continued operation is absolutely essential to the people of the district served by them.

Whether this classification should be undertaken at the time of making the appraisal of physical property, and an attempt be made to classify unit prices, or whether this should be taken up in connection with the intangible values, and solved, as far as the valuation is concerned, by the adoption of such a method as will affect these 138physical values by a subtractive or negative non-physical value, or whether the entire matter should be left for the subsequent work of rate-making or assessment, is one which must be determined at the outset of the physical valuation. It may not be left without determination, as the question will be raised in all probability in the form of an attack on the valuation, if it is not considered and a conclusion reached.

It is the writer's opinion that the application of an intangible subtractive value is the proper solution, except in the case of roads which would not to-day be rebuilt. In fixing a uniform price for identically the same labor or material, whether on a small poverty-stricken road or a main trunk line, no serious injustice is done, provided the price fixed is one which, from a strictly engineering standpoint, is a reasonable figure for cost of reproduction. The differences in class are due, not to special differences in cost of physical property, but rather to differences in earning ability on account of good or poor territory served, efficient or inefficient management, or other reasons not connected with the physical structure; hence such differences are reflected in the earnings, and are clearly elements to be adjusted in the non-physical valuation.

(b) Unit Values.—The general reliability of the appraisal rests very largely on the reasonableness and fairness of the various prices which are applied to the different parts of the property in making the estimate of cost of reproduction. These unit prices should be determined before any actual figures are made. They should be made up from the most complete data available, and, before being tabulated, should be carefully reviewed by all the experienced men engaged on the appraisal, in order that no figure which is either too high or too low may be used.

As a basis, the average of either 5 or 10 years should be used in preference to current prices on all such material and equipment as is fairly stable. Rail, and all forms of rail structures, machinery, locomotives, cars, etc., can be reduced to such a unit that averages can be secured which will eliminate the error due to a period of extreme high or low prices.

In the case of such materials as lumber and ties, the price of which has been steadily rising, due to the growing scarcity of the material, a price based upon a long average is unfair to the corporation, and 139it would appear to be proper to use current prices. There can be no hard-and-fast rule which will be applicable to all appraisals. The unit prices must be such reasonable figures as can be sustained in Court. Their adoption should not be final until every possible test of their accuracy and reasonableness has been made. When they have been adopted, and such modification made as may be fair for certain territory, on account of local conditions, transportation facilities, or other consideration which may affect them, the adopted figures should be applied to all property alike. The use of different unit figures for different roads in the same territory is highly undesirable, and should be avoided.

(c) Right of Way and Real Estate.—The valuation work which has been accomplished during the past decade, and the study of values for taxation and rate-making, have brought into prominence the perplexing features of land values as applied to corporation property. It is comparatively simple to fix within very close limits the reproduction cost of tracks, bridges, locomotives, or any of the other elements of physical structure. Not so with the land. A few years' development may change farm land right of way into city right of way, surrounded by factories, or it may change desirable residential property adjacent to a road into slums.

In view of the clear language of the Court in 82 Fed., 839, and 157 Fed., 849, it is evident that any valuation which does not take into account the appreciation or depreciation of land values cannot be sustained. There can be no serious objection to the doctrine that the property of a corporation generally increases or decreases in value in the same proportion as adjacent property, and it must therefore be admitted that a value based on the sale value of adjacent lands is a reasonable one and must stand. This reasoning, of course, will be subject to exceptions, in the case of terminal properties, docks and water-front properties, and right of way in large cities, but it is believed to be sound when applied to right of way in the country and in small towns and cities.

The next question to be determined is whether the increment of value due to the use of the land is a proper one. It would appear that in the use of land for water-works, gas-works, street-car barns, or other isolated tracts of land used for corporation purposes, this increment would be much less than in the case of a steam or interurban 140railroad, the holdings of which form a continuous and unbroken strip; and, in the case of street railroads, water-works, and like properties, it would be indeed difficult to compute and afterward sustain any considerable increment.

In the case of railway properties, however, it is quite evident that the following facts can be sustained: The actual cost of property purchased for railway purposes will range from two and one-half to five times the selling price of similar and adjacent property used for other purposes. While the actual percentage will vary somewhat, as between land in cities and in the country, and as between fully settled districts well served by roads and sparsely populated regions, yet the difference is very marked, and is capable of determination by an examination of the public records.

This difference can be determined either by a comparison of railway purchases and other transfers, as was done in the later studies in Michigan and in Wisconsin, or by extending the investigation to include assessed valuations, and using the averages, as was done in the work of Mr. Morgan in Minnesota.

In establishing figures for use in a valuation, it would appear to be better to base them on an analysis of actual transfers than to undertake to fix values by any methods of examination and personal appraisal. Enough instances of the wide divergence of expert opinion have been cited to show conclusively that such a method, applied to the thousands of acres of a large corporation, may lead to serious error.

A single attorney or real estate man who has had experience in abstracting and conveyancing, and who has bought some right of way, can examine the records of an average county the largest city in which has a population of 20,000 or less, abstract all railway transfers for 5 years, locate them on the maps, secure data as to actual selling prices of near-by lands, and, in a comparatively short time, be in position to furnish figures which will establish the relation between sales for railway and other purposes in that county. The work that half a dozen such men could do in 90 days would go very far toward establishing with a fair degree of definiteness the value of the railway purpose increment for the majority of counties in any average State. Of course, such an investigation in the large cities is a matter of much greater labor, and would require sufficient time to make complete 141examinations, probably necessitating a special force for such city work.

On every appraisal, the question has been asked, should this railway purpose increment be added to the value of the property? Clearly, yes.

The Supreme Court quotes approvingly from the Tennessee Court, as follows (151 U. S., 479):

"The value of the land depends largely upon the use to which it is put and the character of the improvements upon it."

This is stated again and again. It must be remembered that, for railroad uses, the strip must be continuous; that it must be located so as to permit curves and grades which conform to the requirements of the road; that, no matter what damages may accrue to adjacent property, the road must take its strip; that its use is entirely changed and is a structure placed on it which is capable of vastly greater earnings than the property produced before—all these elements add to the cost of the property when it is acquired for railway purposes, and in the same measure to its value under its new use.

In a new country, where transportation facilities are limited and land cheap, this added increment may be little or nothing, but in a thickly settled State, with many railroads, this element will increase with a good degree of uniformity; while, in terminals, the price rises to almost inconceivable figures. It is capable of being determined, and is clearly an element in the cost of reproduction. The writer holds to the view that it is properly to be placed with the physical values, and that it should not be considered as an intangible element of value.

(d) Depreciation.—Thus far, this discussion has not dealt at length with the subject of depreciation, and it is not considered essential to the purposes of this paper that it be done. The State appraisals have raised a question as to the propriety of using mortality or life tables as compared with personal inspection and the placing of a percentage based on individual judgment. Either method is subject to error. It is certainly desirable to secure the opinion of the man who inspects a bridge, or building, or locomotive, as to its physical condition. It may be desirable to use the check secured by the fact that the age of the building is known and also the average life of structures of its class.

142The result of the Michigan inspection of rolling stock was to sustain fully the rules for valuation issued by the Master Car Builders Association; and clearly, it is not only proper, but extremely desirable, to apply tables to such equipment as freight cars, which are scattered all over the United States, for it would be absolutely impossible to inspect completely those of any road or system. On the other hand, the life of steel rails cannot be determined by any simple table, because the number of car movements, the weight of motive power, the speed of trains, the location (on curves or on heavy grades), and many other conditions affect their life. This also pertains to buildings, locomotives, and other equipment. The character of service rendered, the nature and extent of repairs, and the way in which they have been maintained, add to or take away from any life assigned by tables, so as to render them valueless in many individual instances.

In placing depreciation, allowance should be made, not only for wear and tear due to use, and decay due to the elements, but also to cover that which is due to obsolescence, or the fact that the facility is of an antiquated or inefficient type, and has been superseded in general use by more efficient and economical devices; this may be called commercial depreciation, as distinguished from physical depreciation. The method to be used in placing depreciation is clearly one of the important things that must be determined by each set of appraisers, and, while the writer believes that the use of expectancy tables would greatly facilitate the work in many cases, the data on which to found a complete set of tables and to support them and justify their use are often lacking; therefore, any use of tables should be safeguarded in every possible manner, and personal inspection of fixed property should always be made.

(e) Immaterial Elements of Physical Property.—There are certain expenses, inseparable from the construction of any public works, which are a necessary and proper part of the cost, and are arranged for in the original financing, but are not capable of identification after the completion of construction work. These expenses are:

(1)

Organization,

(2)

Legal expenses,

(3)

Engineering,

(4)

Administration,

(5)

General expense.

143(1) Organization.—This includes the cost of the original organization of the company, the cost of securing the charter and franchises, arranging the financial plan, and securing the funds for construction.

The latter item is intended to include all salaries and expenses of officials in soliciting and negotiating for funds, the services of trustees, and all other proper expenses which are usual and unavoidable in the process of exploiting a projected enterprise and interesting capital therein. Discount on bonds is not included, and any allowances for "premium," or "bonus," or other cash payment to any party for services in securing funds, which are in excess of legitimate expenses, should receive scant consideration at the hands of appraisers.

(2) Legal Expense.—This is for attorneys and all legal expenses, costs, and fees in the organization and during the construction of the property.

(3) Engineering.—This includes reconnaissance, preliminary and location surveys, supervision of construction, and design and superintendence of special structures. The cost of engineering on some of the more difficult properties becomes a very large sum; on certain small lines it may be comparatively small; and in some cases no engineers have been employed at all; but the items of cost covered by this charge have in every case been expended, even if done under the direction of some superintendent.

(4) Administration.—This comprises the cost of the management during construction—the direction of the enterprise.

(5) General Expense.—This is the cost of the general office organization during the construction period, also numerous minor expenses, not distributable.

It is not possible to build any public service plant without incurring all these expenses to a greater or less degree. They are essential elements of cost, and must go into the value of the plant when completed. It can hardly be argued that cost, which in a large property runs into thousands or hundreds of thousands of dollars, has no value at the commencement of operation, nor does it appear that the value is subject to depreciation as long as the property is an operating plant. The writer holds the view that the line between physical and non-physical elements of value should be drawn as follows:

Any value which attaches to the property by reason of any money expended during the construction is part of the physical property 144values; while any value due to the operation of the property which is in excess of the physical value is a non-physical or intangible element. If the correctness of this position be conceded, then all the foregoing items are charges against the physical property, and, as long as it is an operating property, these items of value remain part of the physical property, and the writer contends that they should not be considered as affected by depreciation, as long as the property is a going concern.

Different engineers have included in the appraisal other items which are of a somewhat different nature, and some of which are open to argument; among these are "interest during construction." This item is clearly an allowable one, but serious differences of opinion develop as to a proper amount to allow in making an appraisal.

The corporate history of the Ann Arbor Railroad, in Michigan, shows that it was built in sections of from 25 to 30 miles, and that each section was put into operation as soon as built, so that, while the actual period of construction of the complete property extended over 15 years, no section was under construction much more than one year. This is typical of much of the railroad building of the past, and on such a property the interest charge would be comparatively small.

A proper charge in such a case would clearly not be sufficient in the case of a road several hundred miles in length, through mountains, with tunnels, heavy bridges, and other structures which would extend the actual construction over periods of from 3 to 5 or 6 years, and this is particularly true where the road is a main line or artery, and where local traffic is of minor importance.

The computation of the interest charge is complicated by the fact that interest begins to run as the bonds are taken up, and but a small part of the construction money draws interest during the whole period.

The practice in the State appraisals has been to fix a uniform percentage for all properties. This has had in its favor the argument that it was conservative valuation where taxation is the ultimate end, as the amount was less than one year's interest in every case. It would appear to be more correct to use the corporate history of each company, determine the actual construction periods, and use a rate based on the actual time in each case. This can be fixed with a fair 145degree of accuracy, and a reasonable percentage determined, to equalize the varying periods of time on which the interest runs on different parts of construction.

Discount.—Discount on bonds is claimed by certain railroad men as a proper item for consideration. As has been argued elsewhere, this is not a proper charge against capital. It is an adjustment of the interest rate to the market, or an advance payment of interest; and, in the writer's opinion, should under no consideration be allowed.

Working Capital.—Working capital is another item claimed and conceded in some valuations. It is not a part of the "cost of construction." The money provided for working capital at the outset is not a permanent investment, but is rather a temporary loan paid back out of earnings. The writer fails to perceive any possible argument in favor of adding such an item to the permanent value of the property. In making an appraisal, after the physical value is determined, it is usual to set up a statement of stores, supplies, fuel, and cash on hand, and working capital is certainly shown by the current balance sheet, in the form of cash or accounts receivable. It would appear to have no place in a physical appraisal. Although the items of cash, stores, and supplies were shown in the Michigan appraisal, they did not appear as part of the physical value, nor were they taken into account in computing intangible value, but, being taxable property, they were reported separately.

(f) Contingencies.—The use of a percentage for contingencies in the appraisal in Michigan was bitterly contested by the railroads as improper and excessive. In Michigan 10% was used, in Wisconsin 5½%, and in Minnesota 5 per cent.

Subsequent work in Michigan has demonstrated that the use of as high a figure as 10% was fully justified; and the probability is that the latest Michigan appraisal did not eliminate omissions, inaccuracies of description, and excess cost of construction due to difficulties, to such an extent as to justify much reduction in the percentage.

In making an appraisal, the percentage to be applied to cover contingencies is a proper matter for consideration, and in some cases conditions might well be such that even a smaller allowance than that fixed in Minnesota would be proper, but such cases would doubtless be the exception. The writer believes it to be proper practice to add liberally for the contingency item. The strongest argument against 146it is that it is incapable of being described and located definitely, and is difficult of exact proof. Therefore it has been claimed that it partakes of the nature of a non-physical element, and that if there be any value over and above the physical property value, it will appear with other non-physical elements reflected in the earnings, and may be properly included in the intangible value if such exists. This argument does not appeal to the writer as being final, and he would advocate the use of such a percentage of physical values as appears proper in each appraisal to cover the error due to the extreme difficulty of securing an exact inventory and construction history of the properties.

(g) Design.—Among the matters which were considered in the Michigan work was that of adaptability, or the economical questions of location, design, and construction. It is possible that in some properties, such as water, gas or electric companies, the efficiency of the plant may be very greatly affected by faulty design, uneconomical arrangement, improper construction, and to such an extent that any cost of reproduction, less any ordinary depreciation, would be greatly in error without further allowance. This may also be true of railroads. Excessive curvature and gradients greatly decrease the tonnage hauled by a given power, without decreasing the cost per train-mile.

It is extremely difficult to treat this as a physical element. It is impossible to reduce it to terms of dollars and cents by any usual or customary methods. It is impossible to separate it from any one of half a dozen other items that may be brought up. It opens the door to endless speculation as to what might or might not take place under somewhat different conditions. For these reasons, it was treated in the Michigan appraisal as a non-physical element of value and dismissed from all consideration in the physical appraisal. This was clearly proper, and the subject is only referred to here for the purpose of making clear that it was fully studied and a definite conclusion reached.

Adaptation.—In the sense that this term is used by Mr. Williams and Mr. Morgan, the appreciation or solidification of roadbed was considered in the Michigan work, but given no place in the appraisal. This is a very proper item to consider, but it would appear to be better to include it directly with the roadbed item in the physical appraisal 147as appreciation or solidification. There can be no reasonable objection to adding to the contract prices for grading, ballasting, etc., a reasonable amount to cover, not so much the seasoning and settling of the new roadbed, as the actual money disbursed in work on this new roadbed during the first 3 or 4 years of operation in order to bring it up to the proper operating condition. A very considerable part of the money spent on "maintenance of track" for the first few years after a new line is built is in reality deferred construction cost.

(h) Apportionment of Values.—The apportionment of values of locomotives, cars, miscellaneous equipment, shops, and those other parts of the cost which are not susceptible of separation from the operation of the property as a whole, is an interesting and at times a perplexing problem. While the Courts have viewed as equitable the distribution of values between territorial units when made on a track-mileage basis, it is hardly likely that a Court would look with favor on an appraiser appointed by Michigan giving any consideration to values of bridges, track, or buildings in Ohio. Thus far, every State appraiser has concerned himself only with the fixed physical property in his own State, together with his proportionate share of the floating property. The methods that may be considered are track-mileage, car-mileage, locomotive-mileage, and train-mileage.

The method finally used must be such as will give the fairest result for the property under consideration. In some cases one or more of these methods will give a fair value, while in other cases the same system would be most unjust.

(i) Terminals.—There is no one feature of the entire problem so big with possibilities, and so far from solution, as that of terminal property values and their proper assignment. The property must be considered as an operating unit. Its value must be made up of the values of the parts or elements plus an added value that comes from the operation of the whole. The problem would be simplified if what were sought were the value of a certain railroad, but, as it has been presented up to this time, the problem is: what is the value of that part of this railroad in Michigan? or Wisconsin? or Minnesota? A fairly satisfactory solution of many of the value questions has been obtained, but nothing in the way of a solution of the terminal question. A road owns 300 miles of line in Michigan and 7 miles in Ohio. That 7 miles includes its largest terminal; its principal connections are 148there; it has a fine property, and is in the capacity of landlord to several other roads. What part of that terminal value, if any, is assignable to the State of Michigan? Decidedly, it would not be proper to appraise the entire property as a unit and assign to Ohio only the proportion that 7 miles bears to the whole length; it is equally unfair to appraise it as a Michigan property down to the State line, and add nothing to the value by reason of the terminal.

The influence on the value of the property, of the ownership of terminals in such cities as Chicago, New York, Jersey City, Hoboken, Pittsburg, Detroit, St. Louis, Kansas City, and other large centers of population is tremendous, yet a very large part of the railroad mileage entering those cities belongs to roads which have their largest mileage outside the State in which the terminal is located.

There can be no doubt that the influence of a large terminal affects in a measure the value of every mile of line owned by the company; that this influence is greatest on the principal and direct lines, and less as more remote parts of the system are reached. As yet, no plan has been suggested for determining what this value is or for apportioning it.

The final solution in Michigan was to treat terminal properties within the State exactly as other property was treated, and to assume that, if there was any value assignable to Michigan by reason of outside terminals, it would appear as a non-physical value through the earnings.

When all the phases of this question are considered—the enormous land values, the value due to possession of deep-water terminals, the effect on the business of the entire property by reason of the ownership of such properties as those, for instance, in New York City, Jersey City, and Hoboken—it is evident that no appraisal which has yet been made has established any rule of valuation which may be considered proper for terminals.

It is to be hoped that the work now in progress in New Jersey may be so well supported by the State that it will be possible for the appraisal board to make an exhaustive study of this subject and reach definite conclusions as to the real extent, manner of computation, and proper method of distribution of these values.

(j) Development of the Art.—Is any value assignable to property on account of expenditures by reason of the rapid development of the 149art? This question seems not to have been squarely asked or answered in connection with any of the past appraisals.

Every piece of material and every facility purchased by a company is bought with a definite expectation that it will have a certain life, that during that term of life it will add sufficiently to the earnings to provide a fund for its replacement and earn a profit. No matter whether or not such a reserve is created on the books, this is the theory, and, under it, accident may wipe out certain new property, other property will outlive its expectation and maintain the average life of the entire group of facilities.

There are countless cases where this will not hold. The rapid development of large cities has compelled electric lines to extend largely. The demands of the people for more frequent and more rapid service, and more modern and larger equipment, have greatly shortened the term of life of power-plant equipment and cars. The rapid development in the art of electricity, the congestion of traffic in streets of cities, the enormous increase of train movements, and the use elsewhere of newer types of cars, have compelled the abandonment of millions of dollars' worth of property and the investment of other millions in new and improved facilities to provide for the increased movements of traffic and increased safety to the public. These changes are not due to the fact that the original installation was defective, but to the demands of the public for frequent, safe, and speedy service, demands which are perfectly reasonable. The query is: should a corporation which complies with public demands be compelled to lose capital invested in facilities which have not yet paid for themselves; and which, under a continuance of conditions which existed when they were installed, or any that might then have been anticipated, would normally have a useful life of several more years, and which were abandoned, not by reason of being worn out or unfit for service, but purely because facilities of a more modern type were called for?

To answer this affirmatively increases the hazard of investment greatly in the large centers of population. To answer it affirmatively in some cases might amount to confiscation of property. The writer inclines to the view that, as far as appraisal is concerned, the value due to the remaining life of the abandoned facility, where such abandonment was in response to legal requirement, and where no element of corporate necessity due to increased efficiency or economy of the 150new facility enters into the computation, should be added to the value of the facility replacing it. Any consideration that is given such claims by an appraiser must be most careful, as the inference to be drawn from the decision of the Court in the Knoxville Water Case (212 U. S., 1) is that such elements of value will receive scant consideration unless most fully supported.

If the policy of the management of any public service company is to keep up with the demands of modern civilization, it would appear that such policy should not be discouraged, and, in computing the value of the property, some provision ought to be devised for covering such values as remain in serviceable property at the time of its abandonment in response to public demand; or else the rates for service should be increased sufficiently to compensate the corporation for losses of this nature on the ground that it constitutes an element of extra hazard.

These and like subjects in connection with the appraisal must be taken up during the period of computation and settled. The computing office organization and methods call for no special comment, except to emphasize the need of experienced men, the use of every possible check on the accuracy of the work, and the prime necessity of keeping all notes in such manner that they can be identified and used to re-establish every step taken in the course of the appraisal.

IV.—The Preparation of the Final Figure.

The final form of the work is, of course, so much a matter of personal judgment that even a suggestion may appear to be useless. The use of such a classification as will conform approximately, if not exactly, with that adopted by the Interstate Commerce Commission is more desirable now than it was 10 years ago, as all the roads in the country are using this classification in their accounts, and the more nearly uniform the work of various State appraisals, the better the results will be.