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mmi^oj
1817
ARTES SCIENTIA VERITAS
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VALUATION
OF
PUBLIC SERVICE CORPORATIONS
LEGAL AND ECONOMIC PHASES OF VALUA-
TION FOR RATE MAKING AND
PUBLIC PURCHASE
ROBERT H?VhITTEN, Ph.D.
THE BANKS LAW PUBLISHING CO.
NEW YORK
1912
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jlibta
7'UC
COPTBIOHT, 1912, BT
ROBERT H. WHITTEN
PWM OF T. MOMKY h. SON
aRBBNFlKLO. MASS.. U. S. A.
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^^I^cc^wd^rx^
PREFACE
The valuation of public service property is a subject
that has only recently come into prominence. It has be-
come of immense importance in recent years with the
development of public control over public service cor-
porations. Since the leading case of Smyth t^. Ames in
1898, holding that ordinarily the principal test of whether
a rate schedule or other regulation is illegal and confis-
catory is whether it permits the company to earn a fair
retiun on the "fair value" of its property, the question of
what elements will be considered by courts and conmiis-
sions in determining "fair value" has become the critical
problem in public service regulation. The railroad com-
missions of several states have had detailed valuations
made of all the railroad property in the state. The state
and city public service commissions of which some twenty
have heeoi created in the last few years are invariably
authorized and often required by statute to make valua-
tions of the property of all the railroad, street railway,
gas, electric light and power, water, telegraph, telephone
and other pubUc service property within their jiudsdiction.
The movement for the establishment of similar commis-
sions with valuation powers seems likely to spread until
it becomes practically imiversal.
I have taken up this work as a natural outgrowth of
duties during the past four years that have required the
briefing of the various problems arising in connection
with actual valuations. In working up the subject,
not only the published decisions of courts have been
examined but the unpublished reports of special masters
[iiil
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iv Preface
in equity, the reports of special arbitrators and appraisal
commissioners appointed by the courts, the decisions of
state railroad and public service commissions and the re-
ports of appraisers appointed by local authority. As much
of the material referred to is not available even in a well-
equipped law library, the quotations made are very full,
and sufficient additional information is given to permit
the reader to use and cite the precedents referred to with
assurance that he has a full and accurate statement of
the essential facts. Even opinions from the published
law reports are also quoted and annotated with unusual
fullness. This serves several purposes: First, it facilitates
the study of the subject by bringing the essential material
together; second, many lawyers would not have all the
state decisions referred to conveniently at hand; third,
the book is also designed for use by public utility managers,
accoimtants, engineers and others to whom the published
law reports will not be available. Following the detailed
study of specific cases, with full quotations, there is for
each subject a brief sunmxary of the law and precedents
together with a statement or discussion of the economic
principles involved. This method of treatment while
something of an innovation, seems to possess decided
advantages for a subject of this kind. The subject is new,
and the precedents are diverse. The application of a
particular precedent depends on the exact wording and
context of the decision. No one vitally interested in a
valuation problem can be much assisted by a descriptive
digest of the findings and discussions of the various
courts and commissions. It is almost as economical of
space and very much more useful to have in a treatise
of this kind the actual words of the courts, supplemented
by the necessary explanatory notes.
The questions as to what elements should be included
in a valuation for any specific purpose are fundamentally
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Preface v
economic. But though theories of valuation must be
based on economic principles they can only be given legal
authority through their acceptance by the coiuts and in
the last analysis by the Supreme Ck)urt of the United
States. As the entire question is stUl in a developmental
stage and as many of the points involved may not re-
ceive final authoritative determination for many years, it
has seemed particularly important to include a rather
full statement or discussion of economic principles. The
author realizes that the conclusions indicated by such
discussion are purely tentative. The subject has, how-
ever, been approached with an earnest desire to con-
tribute to just and scientific solutions. In viewing the
general problem from its many sides and from the neces-
sity in making generalizations of seeing whether the
proposed rule can be applied with equal justice in all
like cases, many prejudices are necessarily overcome.
The test of whether the seemingly good rule will "work
both ways" is an excellent corrective. In presenting
this comprehensive view of the problems involved in
determining fair value, it is hoped that not the least
valuable feature will be the opportimity afforded the
reader to think out the various problems with most of
the factors in view and with an opportimity to test the
correctness of his solution by applying it in turn to various
actual cases.
A full bibliography of valuation and depreciation is
included as a final chapter. This is supplemented by a
table of cases annotated so as to indicate the important
topics of valuation treated in each case. Special care
has been taken in the preparation of the index with a
view to miaking it serve the varied needs of the users.
ROBEBT H. WmTTEN.
Broddyn, May, 1912.
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TABLE OF CONTENTS
Preface page iii
TaMeof Oaaea " xxvii
CHAPTER I
PURPOSE OF VALUATION
{ 1. PurpoeeB of valuation.
2. Valuation for public purchase.
3. Valuation for rate purpoaes.
4. Valuation dependent on purpose.
5. Same subject — ^R^;K>rt of Committee National Association of Rail-
way Commissionera.
6. Same subject — ^Report to Massachusetts Joint Board on N. Y., N. H.
AH.R.R.
7. Value for taxation and for rate purposes.
8. Tax and rate purpose — Nebraska Supreme Court in Bee Building
Co. Case, 1002.
9. Tax and rate purpose — District Judge McPherson in St. Louis &
S. F. R. Co. Rate Case, 1909.
10. Tax and rate purpoae-^Arkanaas Railroad Rate Casea, 1911.
11. Value for rate purpose and for public purchase.
12. Capital value and rate and purchase value.
CHAPTER n
FAIR VALUB FOR RATS PURPOSES
§20. Earlier decirions.
21. Justice Brewer in Union Pacific Railway Cases, 1894 — ^No hard and
fast rule of valuation.
22. Circuit Judge Ross in San Diego Land and Town Case, 1896 —
Present value, not cost, the true basis.
23. Circuit Judge Thayer in Kansas Gty Stock-Yards Case, 1897— Cost
plus appreciation in value.
24. Justice Harlan in Smyth v. Ames, 1898 — Fair value of property used
and how ascertained.
25. Justice Harlan in San Diego Land and Town Case, 1899 — ^Reasonable
value at time used.
26. Justice Holmes in San Diego Land and Town Case, 1903 — Reasonable
value at time used.
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viii Table of Contents
§ 27. Circuit Judge Morrow in Spring Valley Water Case, 1903 — ^Reason-
able value at time used.
28. Justice Peckham in San Joaquin Iirigation Case, 1904 — Present
value.
29. Columbus, Ohio, Electricity Rate Case, 1906 — ^Fair present value (A
tangible and intangible property.
30. Justice Peckbam in Consolidated Gas Case, 1909 — ^Fair value gener-
ally includes appreciation.
31. Iowa Supreme Court in Cedar Rapids Gas Case, 1909 — ^Reproduction-
cost-less-depreciation the controlling factor.
32. Oklahoma Supreme Court in Pioneer Telephone Case, 1911 — ^Repro-
duction-cost-less-depreciation the controlling factor.
33. District Judge Evans in Cumberland Telephone Company Case,
1911 — Fair value not determined by construction cost.
34. Wisconsin Railroad Commission in Manitowoc Water Csse, 1911 —
Elements of physical valuation.
35. District Judge Farrington in Spring Valley Water Rate Case, 1911 —
Elements of fair value reviewed.
36. Trend of decisions on fair value.
37. No authoritative determination of standard of value.
38. Recent decimons.
39. Valuation standards.
CHAPTER m
MARKET VALUE AS A STANDARD FOR RATE PURPOSES
§ 50. Usual meaning of market value.
51. Application to railroad valuation.
52. Use by Washington Railroad Commission.
53. Statement of theory by Henry Earle Riggs — Investment value.
54. Competition in its relation to market value theory.
55. Favorable location in its relation to market value theory.
5d. Monopoly value.
57. Reasonable rates can not be based on market value.
58. The misplaced or partially obsolete plant.
59. Same subject — San Francisco Water Rate Case, 1911.
60. Market value the true standard — ^Justice Brewer in Reagan v.
Farmers' L. & T. Co., 1894.
61. Market value standard impracticable — California Supreme Court in
San Diego Water Case, 1897.
62. Value as a going buoness concern — Circuit Judge McCormick in
Metropolitan Trust Co. v, H. & T. C. R. Co., 1898.
63. Value as a producing factor — Qrouit Judge Simonton in Mathew v.
Corporation Commissioners, 1901.
64. Market value— District Judge Trieber in Arkansas Rate Cases, 1911.
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CHAPTER IV
COST OF RBPRODUCTION AS A STANDARD OF VALUS FOR
RATE PURPOSES
§ 70. Aiguments advanoed.
71. Fluctuations in railroad costs — Minnesota rate decisions.
72. Trend of recent decisions.
73. Identical reproduction of existing plant.
74. Identical reproduction — Wm. H. Bryan on waterworks appraisals.
75. Equally efficient substitute plant.
76. Substitute plant — Maine water plant condemnations, 1902, 1904.
77. Substitute plant — Columbus, Ohio, Electricity Rate Case, 1906.
78. Substitute plant— Spring Valley Water Case, 1908.
79. Substitute plant — Discussion by J. E. Willoughby.
80. Substitute plant — Discussion by C. L. Corey.
81. Cost under present or original conditions.
82. Present or original conditions — Discussion before American Society
of Civil Engineers, 1911.
83. Present or original conditions — St. Louis Public Service CommissioL,
1911. •
84. Present or original conditions — Conclusion.
CHAPTER V
ACTUAL COST AS A STANDARD OF VALUE FOR RATE
PURPOSES
§ 95. Actual cost defined.
96. Actual cost a natural standard.
97. Difficulties of determination.
98. Difficulties pointed out in Louisville Telephone Rate Case.
99. Difficulties overestimated.
100. Fluctuations in cost.
101. Extent to which cost changes offset each other.
102. Justice Brewer in Ames v. Union Pacific Railway, 1894.
103. California Supreme Court, 1897.
104. Pennsylvania state courts in Butler Company and Spring Brook
Company Water Cases, 1897, 1899.
105. West Virginia Supreme Court in Coal A Coke Railway Case, 1910.
106. Wisconsin Railroad Commission in Appleton Water Case, 1910.
107. New York Public Service Commission in Kings County Lighting
Case, 1911.
108. Interstate Conmierce Commission in Western Rate Advance Case,
191L
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X Table of Contents
§ 109. Connecticut PubUc Utilities Commiasion rejecta actual cost in favor
of reproduction cost, 1912.
CHAPTER VI
VALUATION OF LAND
1, Treatment of appreciation in land value,
§ 110. Trend of decisions and practice.
111. Consolidated Gaa Case — Decision of District Judise Hou^h.
112. Consolidated Gas Case— United States Supreme Court.
113. Wisconsin Railroad Commission.
114. Committee of National Association of Railway Commissioners,
1010.
115. South Dakota Railroad CommisdcMi, 1910.
116. St. Louis Public Service Commiaaion, 1911.
117. Minnesota Railroad Rate Case, 1911.
118. Interstate Commerce Commission — ^Problem discussed but not de-
cided.
119. AUowance of no return or a reduced rate of return on land.
120. Reduced return allowed on terminals — Minnesota Supreme Court,
1897.
121. Appreciation should be set off against depredation.
122. Appreciation treated as income.
123. Appreciation treated as income for purposes of United States cor-
poration tax.
124. Income method considered.
125. Actual cost o. present value.
f . Cast of reprodvction of railroad right of way,
§ 134. Reproduction cost same as present estimated condemnation coet.
135. Multiples used in various state appraisals.
136. Minnesota Appraisal and Rate Caae.
137. South Dakota appraisal, 1910.
138. Justification of use of multiples.
139. New York Appellate Division rejects use of multiples in tax ease,
1911.
8, Cost of reproduction of terminal land,
§ 140. State railroad appraisals.
141. Minnesota Appraisal and Rate Case.
142. Minnesota Rate Case-*Ayailability for railroad purposes enhances
value.
143. Wisconsin Railroad Commission on availability for special use.
144. Value of adjacent land increased by presence of terminal.
145. Reproduction cost of land as affected by cost of hypothetical build-
ings.
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4. Methods of appnMng land,
i 146. Sales method defined.
147. Sales method discuaaed.
148. Saks method rejeoted in Mfamesota Rate Oaae.
CHAPTER Vn
PAVEMENT OVER BiAINS
§ 160. Consolidated Gas Case.
161. Consolidated Gas Case — ^Appeal to Supreme Court of the United
States.
162. Iowa Supreme Court in Cedar Rapids Gas Case, 1909.
163. Wisconsin Railroad Conmiission — Rate Cases.
164. VHsoonsin Railroad Commission — Purchase Cases.
165. Opinions of Hagenah, Corey and Marston.
166. Purchase of water plant at Trenton, Mo.
167. Des Moines Water Rate Case, 1910-1911.
168. New York Public Service Commission in Gas Rate Case, 1911.
169. Sununary and conclusion.
CHAPTER Vm
PROPERTY DONATED OR ACQUIRED WITHOUT COST
i 180. State railroad appraisals.
181. Minnesota Supreme Court on railroad grants, 1897.
182. California Supreme Court on water services, 1897.
183. United States Circuit Judge Morrow excludes fences not built by
company, 1911.
184. Wisconsin Railroad Commission on services provided at consumer's
expense.
185. Opinion of C. L. Corey on services furnished by consumer.
186. State and dty aid in grade separation improvements.
187. City's grade separation contribution considered by New York Public
Service Commission.
188. Grade separation contributions in appraisal for capitalisation.
189. Conclunon as to grade separation contributions.
190. Statement of problem of donated property.
191. Contributions by the company.
192. The jnore equitable rule.
CHAPTER IX
PROPERTY CONSTRUCTED OUT OF SURPLUS
§ 200. Valuation of property constructed out of surplus.
201. Pennsylvania Supreme Court in Brymer v. Water Company, 1897.
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§ 202. Maine Water Plant Condemnation Case, 1002.
203. Interstate Commerce Commission in Spokane v. Northern Pacific,
1900.
204. Right to a rate of return adequate to construct betterments.
205. Betterments Out of earnings — New York Public Service Conunis*
sion, 1011.
206. Betterments out of eamingp — American Telephone and Telegraph
Company, 1012.
CHAPTER X
UNUSED PROPERTY
§ 210. Discarded property.
211. Discarded property — ^Wisoonmn Railroad Commission.
212. Inclusion of river intake and filter galleries, Wisconsin.
213. Discarded property — Des Moines Gas Rate Case, 1806.
214. Land acquired in advance of present need — New York Pubhc
Service Conunission.
215. Land—San Francisco Water Rate Case, 1008-1011.
216. Excessive investment in plant.
217. Excessive investment — New Jersey Chancery Court, 1005.
CHAPTER XI
AVBRAGB PRICE v. PRESENT PRICE
§ 230. Method followed by Wisconsin Railroad Conunission.
231. Michigan and Minnesota railroad appraisals.
232. Rule that neither the highest nor lowest prices should govern*
233. Average price for period equal to construction period.
234. General considerations.
CHAPTER Xn
OVERHEAD CHARGES
§240. Introductory.
241. Appraisal of Chicago surface railwasrs, 1006.
242. Appraisal of Chicago Consolidated Traction Company, 1010.
243. Appraisal of Chicago gas plant, 1011.
244. Cleveland street railway appraisal, 1000.
245. Columbus, Ohio, Electricity Rate Case, 1006.
246. Des Moines, Iowa, Water Rate Case, 1010.
247. Lincohi, Neb., Gas Rate Case, 1000.
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§ 248. Appraisal of street railways for Massachusetts Validation Board,
1911.
249. Appraisal of N. Y., N. H. & H. R. R. for Massachusetts Validation
Board, 1911. •
250. Memphis, Tenn., water plant appraisal, 1902.
251. Michigan railroad appraisal, 1900-1901.
252. Minnesota railroad apprsdsal, 1908.
253. New Jersey Public Utility Commisfflon, 1911.
254. New York Consolidated Gas Case, 1907.
255. New York Public Service Commission, Plrst District, 1911.
256. Oklahoma Telephone Rate Case, 1911.
257. South Dakota railroad appraisal, 1910.
258. Washington railroad appraisal, 1908.
259. Washington Railroad Commisaon, 1910.
260. Seattle, Wash., Telephone .Rate Case, 1910-1911.
261. Wisconsin railroad appraisal, 1903.
262. Wisconsin Railroad Commission.
280. Engineering and superintendence.
281. Contingencies.
282. Contingencies — Michigan railroad appraisal, 1900-1901.
283. Contingencies — Massachusetts appraisal of N. Y., N. H. & H. R. R.,
1911.
284. Contingencies — St. Louis Public Service Conmiission, 1911.
285. Contingencies — Oklahoma Telephone Rate Case, 1911.
286. Contingencies — ^Wboonsin Railroad Commission, 1911.
287. Contractor's profit.
288. Contractor's profit — St. Louis Public Service Commission, 1911.
289. Contractor's profit — New York Public Service Commission, First
District.
290. Contractor's profit — ^Valuation of Falmouth, Mass., water plant.
291. Interest during construction.
292. Interest — Minnesota Railroad Rate Case, 1911.
293. Interest — Oklahoma Telephone Rate Case, 1911.
294. Interest — ^Wisoonsin Railroad Commission.
295. Interest — St. Louis Public Service Commission, 1911.
296. Interest — New York Public Service Commission, First District,
1911.
297. Interest — State railroad appraisals.
298. Interest— Massachusetts appraisal of N. Y., N. H. & H. R. R., 1911.
299. Promotion and organization.
300. Promotion — St. Louis Public Service Commission, 1911.
301. Promotion— New York Public Service Commission, Second District,
1906.
302. Promotion— New York Public Service Commission, First District,
1912.
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CHAPTER Xm
discotjut on bonds
§320. Definition.
321. Treatment in uniform Byitems of aeooimts.
322. Treatment in connection with cafntaJiiation.
323. Treatment in public purchase cases.
324. Cleveland and Chicago street railway settlements.
325. New Yoric subway contract.
326. State railroad appraisals.
327. Valuation for rate purposes.
328. Washington Railroad Conmussion — ^Rate Case.
329. Wisconsin Railroad Commission — Rate Cases.
330. Columbus, Ohio, Electricity Rate^Case, 1005<
331. linoohi, Neb., Gas Rate Case, 1009.
332. Minnesota Railroad Rate Cases, 1910.
333. Sununary — Discount in Rate Cases.
CHAPTER XIV
WORKING CAPITAL
§340. General.
341. CapitaUsation of working capital.
342. Working capital as estimated for tax purposes in Great Britain.
343. Wisconsin Raihroad Commission, 1910-1911.
344. Kew York Consolidated Gas Case.
345. New York Public Service Commission, First District, 1911.
346. Chicago gas plant appraisal, 1911.
347. Iowa Gas and Water Rate Cases.
348. Uncohi, Neb., Gas Rate Case, 1909.
349. Louisville Telephone Rate Case, 1911.
350. New York Special Franchise Tax Case, 1911.
CHAPTER XV
PIECEBftEAL CONSTRUCTION
§ 360. Treatment of piecemeal construction by ^^Isconsin Railroad Com-
mission.
361. Oklahoma Supreme Court denies allowance for piecemeal construc-
tion.
362. Discussion of piecemeal construction.
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TaBLB of CoNTBNTB XV
CHAPTER ZVI
ADAPTATIOlf AUD SOUDIRCATIOV
§ 370. Definition — Minnesota railroad appraiMl, 1908.
371. Waabington nuboad appraiaal, 1008, and mibaeqiMnt rate Tahia-
tbns.
372. Teias, Michtgan and Wiaoonflln railroad appraiaals.
373. South Dakota ralboad appraisal, 1910.
374. Appraisal of N. Y., N. H. A: H. R. R., 1911.
375. Texas Railroad Rate Cases, 1892-1896.
376. Oklahoma Raiboad Rate Case, lOlO-^Iiiynoal and commercial
adaptation.
377. Minnesota Raiboad Rate Case, 1911.
378. New YcMrk Raiboad Tax Case, 1911— 8eas(ming disallowed.
379. Irrigation Rate Case, 1911 — Claim for solidificatbn of earthwork
rejected.
380. Adaptation of street railway — New York Public Service Commis-
sion, Fbst District, 1912.
381. Alabama Raiboad Rate Cases, 1912.
382. SuniBUtfy.
CHAPTER XVn
FHT8ICAL DSPRBCUnON
§990. Depredation problem.
391. Physical depreciation and functional depreciation.
392. What is depredation?
393. Other definitions.
394. Straight line method of measuring depreciation.
395. Sinking fund method of measuring d^redation.
396. Sinking fund method cfiscussed.
397. Present worth method of measuring depreciation.
398. Present worth method applied to a class.
399. Present worth method applied to system as a whole.
400. Other methods oi measuring depredatioa.
401. Unifom uiTeatment cost method of adjusting depredation.
402. New York Public Service Commission, First District, rejects sink-
ing fund method.
403. Stedght line method in New Yo^ City Street Railway Fare
Case.
404. Depredftiioti rule coatainod in onif onn water supply accounts,
1911.
405. Depredation of overhead charges.
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xvi Table of Contents
CHAPTER XVm
COST-]fBW V. COST-LBSS-DEPRECUTION
§420. Statement of problem.
421. Importance of consideration that the entire initial capital can not be
retained in the bufilness.
422. Deduction of depreciation necessary to secure uniform investment
cost and uniform reasonable rate of charge.
423. Unamortised depreciation.
424. United States Supreme Court considers depreciation reserve in-
vested in improvements, 1900.
425. Cost-of-reproduction-new approved — Massachusetts appraisal of
N. Y., N. H. & H. R. R., 1911.
426. Cost-of-reproduction-new approved — ^Appraisal of Chicago gas
plant, 1911.
427. Cost-of-reproduction-new approved — Wisconsin Railroad Coounis-
sion.
428. Cost-of-reproduction-new approved — Columbus, Oluo, Electricity
Rate Case, 1906.
429. Cost-of-reproduction-new when depreciation is computed on sinking
fund plan — New Jersey Commission, 1911.
430. Deduction of existing depreciation necessitates allowance for annual
depreciation — United States Circuit Court, 1908.
431. Cost-of-reproduction-less-depreciation the approved rule.
432. Oklahoma Supreme Court in Telephone Rate Case, 1911.
433. Cost-of-reproduction-new rejected — New York Public Service Com-
mission, First District.
CHAPTER XIZ
FUNCTIONAL DEPRBCUTION
§450. Definition.
451. Ordinary functional depreciation.
452. Extraordinary functional depreciation.
453. Functional depreciation actually accrued should be deducted.
454. Functional depreciation deducted in Holyoke, Mass., purchase
Case, 1902 — ^Report of appraisers.
455. Hypothetical functional depreciation.
456. Hypothetical depreciation disallowed in New York City Eighty
Cent Gas Case.
457. Hypothetical depreciation apparently allowed in Washington ap-
praisals.
458. Treatment of past losses due to supersession.
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Table of Contents xvii
§ 459. Problem of past superaeBsion dlBcuased by Henry Earle Riggis.
460. United States Circuit Court in Des Moines Gas Rate Caee, 1806—
Investments in unsucoessful experiments excluded.
461. United States Circuit Court in Milwaukee Street Railway Fare
Case, 1898, holds superseded horse car equipment entitled to
equitable consideration.
462. United States Supreme Court declares that past supersession may
not be included.
463. Street railway supersession excluded in capitalization case — New
York Public Service Commission, 1910.
464. Supersession due to consolidation — ^Wisconsin Railroad Commis-
sion, 1911.
465. Casualty.
CHAPTER XX
ANNUAL DEFRBCUTION ALLOWANCE
i 480. General.
481. Should cover physical and ordinary functional depreciation.
482. Maintenance accounts include certain renewals.
483. Allowance in rate case for depreciation aheady accrued.
484. Accrued depreciation — ^Washington Supreme Court in Electric
Railway Rate Case, 1911.
485. United States rule as to depreciation allowance in assessing corpora-
tion income tax, 1911.
486. Wisconsin Railroad Commission — Discussion of annual allowance —
Sinking fund method — Maintenance accounts.
487. New York Public Service Commisnon — Maintenance account in-
cludes many renewals — Sinking fund method — Functional de-
predation.
488. Allowance on sinking fund plan rejected in Louisville, Ky., Tele-
phone Rate Case, 1911.
489. Depreciation must be deducted to determine net income — New York
courts in Franchise Tax Cases.
490. Sinking fund plan rejected by New York court in Tax Case,
1911.
491. Allowance for functional depreciation — New York courts in Tax
Cases.
492. Three per cent, depreciation allowance required by Massachusetts
statute for municipal Ughting plants.
493. Six per cent, allowance in Chicago Street Railway Assessment Case,
1902.
494. AUowance in New York Street Railway Tax Case, 1909.
495. Twenty per cent, gross receipts of street railway prescribed in Capi-
talisation Case— New York Conmussion, 1912.
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xviii Table of Contents
§ 496. Three per cent, allowance in Bavamiah Street Railway Ihae Caae^
Georgia Railroad Commission, 1912.
497. Five per cent, allowance in Columbus, Ohio, ESeotricity Rate Case,
1906.
498. One per cent, allowance on sinking fund basis in Des Moines, Iowa,
Water Rate Case, 1910.
499. One and s^ven-tenlte per cent, afibwance on sinkbig ftmd bads in
Cedar Rapids, Iowa, Gas Rate Case, 1909*.
500. Two per cent, idlowance in Chica^ Gas Rate Report by W. J. Hag-
enah, 1911.
501. Allowance in San Frandsco Wafer Riate Case, 1911.
502. Three per cent, allowance on straight line basis in Inlgatbn Rate
Case, 1911.
503. Seven and three-tenths per cent, annual allowance — Massachusetts
telephone appraisal iw rate purposes, 1909 — Discussion of de-
preciation.
504. Seven per cent, allowance in Oklahoma Tefephone Rate Case, 1911 —
Allowance to cover only current replacement declared inadequate.
505. Seven per cent, allowance in Louisville Ky., Telephone Rate Case,
1911.
506. Missoim Supreme Court in Tel^one Rate Case, 1911.
507. Ten per oenti allowance in Arkansas Electricity Rate Case, 1911.
508. Depreciation allowance refused by California court, San Diego, Cal.,
Water Rate Case, 1897.
509. Depreciation allowance refused by Iowa court in 1902 but approved
In 1909.
510. Depreciation aBowanoe apparently refused by United States Su-
oreme Court in 1903 but recognised in later <
CHAPTER X3Q
GOING CONCERN IN IPtmCHASB CASES
i 520. Purchase of Kansas City water plant, 1894.
521. Kansas City water plant purchase — Opimon of Justice Brewer.
522. Kansas City water phmt purchase — ^DouUe aHbwaaoe for estab-
lished business.
523. Kansas City water plant purdnoe— Justice Biewer's decision not
based on precedent.
524. Justice Brewer in Railroad Tax Case, 1894, refem ta additional
value from operation as a single Hne.
525. Massachusetts Supreme Judicial Court, 1897— Purchase of New-
buryport water plant.
526. Gloucester, Mass., water plant purdiase, 1899-1901.
527. Gloucester appraisal upheld by Maasachuaetts court.
528. Purchase of Hoiyoke, Mass., gas and electiie plant, 1908.
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Tajslb or Contents xix
§ 520. Rhode Islaiid water plant purchase, 1901 — ^Allowance for going
oonoem refused.
530. Mobile, Ala., water plant appraisal, 1903 — ^No allowance for going
vahie.
531. Purchase of Norwich, Conn., tigbting planl;,. 19Q4«
532. Purchase of Galena, Kan., water plant, 1906.
533. Maine water plant condemnation cases^ 1902, 1904 — Value of
structure in use.
534. Pennsylvania Water Plant Co&demnation Case, 1909.
535. Omaha v, Omaha Water Co., Supjoeme Court of the United States,
1910.
536. Summary.
CHAPTER ZZn
GOING CONCERir IN RATE CASES
i 550. Tesias Railroad Rate Case, 1888.
551. Cedar Rapids, Iowa, Water Rate Cbbb, IMS^-DistiDstiBB between
value for rate purpose and value for purahase.
552. Columbus, Ohio, Electricity Rate Caae, ]2906w
553. Consf^dated Gas Case — Report of iqieoial nuMrtcr.
554. Consolidated Gas Case — United States District Judge HfNi^
555. Consolidated Cras Case — United States Supreme Court.
556. KnoxviUe Water Rate Case, 190O.
557. Cedar Rapids, Iowa, Gas Rate Case,. 1909, 1912.
558. Urbana, Ohio, Water Rate Case, 1909—14% aHowanoe for going
value.
559. Cleveland street railway apprsusal, 1909— No aUowanoe. for going
vahie.
560. South Dakota raihroad appraisal, 1910.
561. Oklahoma Railroad Rate Case, 1910.
562. Dee Moines, Iowa, Water Rate Case, 1910, 1911—10% alk)waiice
lor going value.
563. San Francisco Water Rate Cases, 1903-1911.
564. LouisviUe, Ky., Telephone Rate Case, 1911— Valuation as a going
concern identified with cost-of-r^productioa-less-depceciaitioQ.
565. Oklahoma Telephone Rate Case, 1911--20% on reproductk>n cost
for cost of establishing the business.
566. OaUand, Cal., Water Rate Cas.-^. 1911— No gpiz^ value included—
Deficit method rejected.
567. New York Public Service Commiamon, Fixst District — Gsmg con-
cern considered in rate of return but not in fair value»
568. New York Publio Service Commission, FLrst District— Adjttstment
of parts, established connections and bugineng eKpeoenee as ele-
ments of going Qoaoeni*
569. Summaiy.
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XX Table op Contents
CHAPTER XXm
GOmO CONCERN AS THE VALUE OF A CREATED INCOME
§ 580. Definition— Alvord and Metcalf .
581. Definition — Benezette Williams.
582. Going value development period — ^Water supply.
583. First theory as to development period.
584. Second theory as to development period.
585. Third theory as to development period.
586. Development period for other utilities.
587. Value of earnings during construction period.
588. Income under existing rates v. Income under reasonable rates.
589. Wisconsin Railroad Commission disapproves comparative plant
method.
590. New York Public Service Commission, First District, disapproves
comparative plant method.
591. United States District Court in San Francisco Water Rate Case
rejects comparative plant method.
592. Value of created income bears no direct relation to cost.
593. Summary.
CHAPTER XXIV
GOING VALUE RULE OF WISCONSIN RAILROAD COMMISSION
§ 600. Earlier Cases — Going value a recognized element in valuations for
purchase.
601. Going value included in valuation for rate purpose — Cost of estab-
lishing the business the measure of going value.
602. Certain methods of determining going value rejected.
603. Cost of establishing the business method explained in detail — State
Journal Printing Company v, Madison Gas and Electric Com-
pany.
604. Error in treatment of annual appreciation in land value.
605. Error in treatment of annual depreciation allowance.
606. Rate of return during development period.
607. Not all past losses may be capitalized as going value.
608. Losses due to careless and unprogressive management may not be
capitalized.
609. Expense of certain litigation excluded.
610. Losses due to competition considered.
611. Cost of business promotion may be offset by earnings.
612. Effect of application of Wisconsin rule on valuations fixed.
613. Consideration of Wisconsin rule by ooiuts and other commis-
sions.
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Table of Contents xsd
§ 614. San Francisco Water Rate Case, 1911— Deficit method disap-
proved.
615. New Yoris Public Service Ck>mmiBBion disapproves capitalisation of
early losses.
616. Report on Peoria waterworks rates, 1910.
617. Conclusion.
CHAPTER XZV
THE THBORY OF GOING CONCERN VALUE
i 630. Franchise and going concern in large measure inseparable.
631. Commercial vfUue as a going concern.
632. Good will. ^
633. Good will a characteristic of competitive business.
634. Good will — Court decisions.
635. Good will — Wisconsin Railroad Commission.
636. Going concern value — Definition.
637. Methods of estimating going concern value.
638. Market value v. Cost as a measure of going concern value.
639. Cost of reproduction v. Actual cost as a measure of going concern
value.
640. Cost of establishing paying business — Rate Case.
641. Cost of subsequent promotion of business — Rate Case.
642. Going concern value — Rate Case.
643. Going concern value — Public purchase.
644. Cost of service theory of determining going value as set forth by
Frank F. Fowle.
CHAPTER XXVI
FRANCmSE VALUE IN PURCHASE CASES
§ 660. Pennsylvania Supreme Court in Toll Bridge Condemnation Case,
1885 — ^Value based on earnings.
661. New York water plant condemnation, 1893.
662. Monongahela Navigation Company v. United States, 1893-'Com-
pany entitled to compensation for loss of franchise to take tolls.
663. Massachusetts Supreme Court in Water Plant Purchase Cases,
1897, 1901— Right to Uy pipes of no value to city.
664. Rhode Island Supreme Court in Water Plant Purchase Case, 1901
—Town's option to buy does not extinguish value of unexpired
ifranchise.
665. Connecticut Supreme Court in Purchase Case, 1904— Earning value
but not franchise value considered.
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xni Tabub of CoNom^iB
{ 666. Maine SupTCBie Court in Water I^ant Condemnation Cases, 19Q2,
1004 — Rules to govern appraiaera.
667. ^^seonsin Bailroad Commiiwion in a paroi»Be case under the in-
determinate permit.
668. Pennsylvania Supreaie€ourt in Water Plant Purchase Case, 1909—
Value of right to charge reasonable rates.
669. Summary.
GELAPTSSLiami
FiAifcmss VALtni m itAn cases
§ 680. San Pnmcisoo Water Rate Case, 1903— No distindtion i>etweeii
condemnation and rate regiHation.
681. Columbus, Ohio, Electricity Rate Case, 1906— FnmcluM has value
but no specific value assigned.
682. Consolidated Gas Case — Opinion of State CommiMiott — i^andnse
value excluded.
683. Consolidated Gas Case — Prrifminnry injunction.
684. Consolidated Gas Case — ^Report of special master.
685. Consolidated Gas Case — ^Permanent injunction granted.
686. Consolidated Gas Case— Appeal to Suprame Court of tlie United
States.
687. Consolidated Gas Case— Summary.
688. Lincohi, Neb., Gas Rate Case, 1909— FkanchiBe vahie excluded.
689. Wisconsin Railroad Commission— ^Question dtsoussad — ^Franchise
value should be excluded,
690. SanTrancisco Water Rate Case, 1908— District Judge Fairington—
Preliminary injunction.
691. San Francisco Water Rate Case — ^Permanent injunction granted —
No separate franchise value found.
692. Appraisal of Chicago gas plaiit, 1911— 'Franchise value excluded.
693. Louisvilie, Ky., Tel^hone Rate Case, 1911 — Franchise value ex-
cluded.
694. Missouri Supreme Court in Te^phone Rate Case, 1911 — F^iuusluse
value excluded.
695. Stanislaus County, Cal., Water Rate Case, 1911--Franch]8e should
be induded, but omitted in present case on account of lack of
evidenoe.
096. €kirV«smah Street Railway Fare Case, 1912— Franchise value ex-
cluded by Georgia Railroad ComnuBsi<m.
607. Valuation of a lucrative contract excluded — New York Public Serv-
iee Coumisnon, Fiiet District, 1911.
698. Alabama Raibx)ad Rate Cases, 1911, 1912— Franchise value in-
I duded based on tax value.
699. Summary.
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Tajbu <» CoNTSN^ xxiii
CHAPTER XXVm
APPtMSM. OF FRAlfCmtn YALim
S 710. Oopdandortnet aU9B?»y«ettleKi<»t.
mi. MiOiigaaraUvBadjip^f^uMl (or^taspuipoaQS, 1900, 1901.
712. Proposed modification of above rule.
713. New YodE^xcial'teBohiae.taK — ^Net.eamiiigBrule.
7U. Nefff Yock ^peoialiDBBqhise tex — Net-eanun^i rule ontioieed.
716. Chicago Street Ridlway Tax Case — Net earmngpmle aRptted.
CHAPTKtnOX
THE THEORT OF FRANCmSS ITALUB
§ 720. The economic function of the f cuichise.
721. Franchise value in rate cases.
722. Franchise value in condemnation.cases.
CHAPTER XXZ
BATB OF RBTURIC
f 730. Relation of rate of return to fair value.for,ffate «nil iiunhase pur-
poses.
781. United States Suprme Court, IfiMr^ftailroad entitled to soane
profit.
782. CaBfornia fiiqirome Court, 1897--T8QBieinaqpn over lowest mte^for
borrowed money.
788. WauBKiA Supreme Court, 18Q7-^M% ^P jternuods and 5% on
other railroad property not confiscatory.
784. Umted States Ciiouit -Onvt, 1806*^^% ratm ocmfiseatory—
Street raUway.
785. tJAHedStatesrGireuitC(iiir<^t902— e%«£«irretw^^
736. Iowa Supreme Court, 1902—4.4% to 5>i% not ooafiscatory—
Wftter company.
737. United States Circuit Court, 1903—^% mJTHnwBa xate— Water
-eoinpany.
788. United States Circuit Court, 1908^-tLwd rate of interest the mini-
mum rate — ^Raihroad.
780. United States Supreme Gaurt, 1904^-^% letum is-nat oonfisoatory
— ^Irrigation company.
'940. ^Ihiited Stotss'GHcuitiGaurt, 1SD4^^% mmimum retum— WMer
company.
m. 'Miine St^pfeme (Court, lfN)4*^lteM0iuifafe mte dependent on cir-
cumstances.
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xxiv Table op Contents
§742. New Jersey Court of Chanoeiy, 1905 — 5% minifnnm return —
Water company.
743. United States Circuit Court, 1906— Legal rate of interest (6%) the
Tnitiimnm rate — ^Elcctric Company.
744. United States Circuit Court, 1907—7% a fair return— Telephone.
745. New York Appellate Division, 1907— Saratoga Springs Gaa and
Electric Rate Case.
746. Pennsylvania Supreme Court, 1908 — Legal rate of interest (6%)
the minimum — Consideration of rate necessary to induce original
investment.
747. United States District Court, 1908— Legal rate of interest (8%)
the minimum fair return — ^Railroad.
748. United States District Court, 1908 — 5% a reasonable return —
Water company.
749. Consolidated Gas Case — State oonunission holds 8% a fair return.
750. Consolidated Gas Case — District Judge Hough holds 6% a fair
return.
751. Consolidated Gas Case— United States Supreme Court holds 6%
a fair return.
752. United States Supreme Court, 1909— Not decided whether 4% re-
turn would or would not be confiscatory — Water company.
753. Interstate Conuneroe Commission, 1909— Railroad entitled to con-
siderably more than 4%.
754. United States District Court, 1909 — 6% a fair return for railroad.
755. United States District Court, 1909 — 6% a minimum return — Gas
plant.
756. New York Court of Appeals, 1909— Legal rate of interest (6%)
a fair return — ^Water company.
757. United States Circuit Court, 1909-^% a reasonable return— Water
company.
758. United States District Court, 1909-^% a reasonable return— Tele-
phone company.
759. Iowa Supreme Court, 1909 — 5% to 6% a reasonable return — Gas
company.
760. Oklahoma Corporation Commission, 1911 — 8% a fair return —
Telephone.
761. Chicago gas rate report, 1911 — 6% v. 7% as a fair rate of return.
762. United States Circuit Court, 1911 — 7% the minimum reasonable
return — ^Railroad.
763. United States Circuit Court, 1911—7% the minimum reasonable
retiun — ^Telephone.
764. United States Circuit Court, 1911—6%, plus 1^% for lean years,
a fair return — Railroad.
765. Nebraska State RaOway Commission, 1911 — 8% a fair return —
Street railway.
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Table op Contents xxv
S 766. United States District Court, 1911—3.97% return is confiscatory
— ^Water company.
767. Arkansas Supreme Court, 1911—6% to 10% a fair return— Legal
rate of interest — ^Electric company.
768. Missouri Supreme Court, 191 1—6 % a reasonable return — ^Telephone.
769. Washington Supreme Court, 1911 — ^7% a fair return— Hectric
railway.
770. United States Circuit Court, 1911— «% a fair return— Water com-
pany.
771. New York Court of Appeals, 1911 — ^Fair rate of return a question
of fact to be determined by lower court — ^Tax Case.
772. New York Public Service Commission for the First District— 7 J^%
a fair return — Gas company.
784. Review of attitude of Supreme Court of the United States.
785. Review of attitude of federal and state courts.
786. Attitude of courts and commissions contrasted.
787. Distinction between fair return in an administrative and judicial
788. Same distinction upheld by California Supreme Court, 1911.
789. Federal court in San Francisco Water Rate Case, 1908.
790. Responsibility of regulatory commissions.
791. Elements of a reasonable return — ^Wisconsin Railroad Comsussion.
792. Ordinary method of financing in its relation to* fair rate of return.
793. Three standards of reasonableness.
794. Original risk standard.
795;^ Original risk standard — Court decisions.
796. Standard of present risk for new enterprise.
797. New enterprise standard — ^Approval by commissions and courts.
798. Present market rate standard.
799. Condufflon.
800. The sliding scale and other automatic methods of securing voluntary
rate reductions and of rewarding efficient management.
CHAPTER XXXI
RFLES FOR APPRAISERS IN MAINE CONDEMNATION CASES
§ 810. Kennebec Water District Case, 1902.
811. Brunswick and Topsham Water District Case, 1904.
CHAPTER XXXII
BIBLIOGRAPHY OF VALUATION AND DEPRECUTION
§ 815. General.
816. Electrical property.
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xm Tabus^ of OoNtwmB
{817. GttspkmtB.
818. Railroads.
819. Straot^vleleoteierHlfmje.
820. Telephone.
821. WaterwDEkB.
822. Qoingmdue.
823. Depredation.
Index .page 747
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TABLE OF CASES €ITED
Advance in Iftates, Eastern
Case, 20 I. C. C, R. 243,
February 22, 1911.
§ 37, Fair value.
204, Surplus.
Western
R. 307,
Advance in Rates,
Oaae, 20 I. C. C.
February 22, 1911.
§ 108, Actual ooBt.
118, Land appreoiatiim.
204, Surplus.
800, Rate of return.
Advances in Freight Rates,
In re Proposed, 9 I. C. C. R
382, decided April 1, 1908.
§ 37, Fair value.
Ames V, Union Pacific Railway
Ck>mpany, 64 Fed. 165, No-
vember 12, 1894.
% 11, Purpose of valuation.
21, Fair value.
102, Actual cost.
Appleton V. Appleton Water
Works Company, 6 W. R. C.
R. 215, May 14, 1910.
§ 106, Actual ooet
164, Pavement over mams.
211, Unused property.
230, 234, Unit price.
607, Going coooem.
689, Franchise.
Appleton Water Works, In re,
6 W. R C. R 97, DecenAerT,
1910.
§ 164, Pavement over mains.
607, 612, Going concern.
Application of.
ticular name.
Arkadelphia Elef^ric Light Ck>.
V, City of ArkadelpUa, 96
Ark. — , 137 S. W. 1093, May
1, reii.
{ '507, 'Depreciation.
767, Rate of return.
Arkansas Rate Cases, In re,
187 Fed. 290, May 8, 1911.
S 10, Purpose of valuation.
64, Market value.
764, Rate of return.
Ashland v. Ashland Water
Company, 4 W. R, C. R 273,
November 1, 1909.
§ 163, Pavement over mains.
184, Property donated.
Bee Building Co. v. Sava^.
See State ex rel. Bee Buildmg
Co. t;. Savage.
Beloit t;. Beloit Water, Gas
and Electric Company, 7 W.
R. C.R. 187,July 19, 1911.
§ 163, Pavement over mains.
184, Property donated.
211, UniDsed property.
286, Overhead charges.
343, Working capital.
360, IHecemeal construction*
396, Depreciation.
612, Gomg concern.
Bristol V. Bristol and Warren
Water Works, 23 R. I. 274, 49
Atl. 974, July 27, 1901.
§ 520, 533, 634, Gomg concern.
664, Franchise.
See the par- Brooklyn, In Matter of City
of, 73 Hun, 499, December,
[xxvii]
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xxvm
Tablb of Cases Cited
1893; affirmed 143 N. Y. 596,
38 N. E. 983, 26 L. R. A. 270,
November 27, 1894; affirmed
as Long Island Water Supply
Co. V. Brooklyn, 166 U. S.
685, 17 Sup. Ct. 718, 41 L. ed.
1165, April 16, 1897.
§ 661, Franchise.
Brooklyn Heights Railroad
Co. See People ex rel. Brook-
lyn, etc.
Brunswick and T. Water Dis-
trict V. Maine Water Co., 99
Me. 371, 59 Atl. 537, Decem-
ber 14, 1904.
§ 76, Cost of reproduction.
233, Unit price.
- 291, 292, Overhead charges.
533, 563, Going concern.
666, 669, Franchise.
741, Rate of return.
811, Appraisal rules.
Brymer v, Butler Water Com-
pany, 179 Pa. 231, 36 Atl. 249,
January 4, 1897.
§ 104, Actual cost.
201, Surplus.
Buell v. Chicago, Milwaukee
& St. Paul Railway Company,
1 W. R. C. R. 324, February
16, 1907.
§ 180, Property donated.
600, Going concern.
798, Rate of return.
C. H. Venner Co. v. Urbana
Waterworks, 174 Fed. 348,
November 6, 1909.
§ 72, Cost of reproduction.
558, 569, Going concern.
757, Rate of return.
Capital City Gas Light Com-
pany V. City of Des Moines,
72 Fed. 829, January 8, 1896.
§ 75, Cost of reproduction.
213, Unused property.
460, Depreciation.
Cashton Light and Power Co.,
In re, 3 W. R. C. R. 67, No-
vember 28, 1908.
§ 600, 635, Going concern.
667, Franchise.
Cedar Rapids Gaslight Co. v.
Cedar Rapids, 144 la. 426,
120 N. W. 966, May 4, 1909.
§ 31, Fair value.
72, Cost of reproduction.
162, Pavement over mains.
232, Unit price.
240, 291, 299, Overhead
charges.
347, Working capital.
499, 509, Depreciation.
557, 569, Going concern.
759, Rate of return.
Cedar Rapids Gaslight Com-
pany V. Cedar Rapids, 223
U. S. 655, March 11, 1912.
§ 31, Fair value.
162, Pavement over mains.
232, Unit price.
299, Overhead charges.
347, Working capital.
499, 510, Depreciation.
557, 569, Going concern.
759, Rate of return.
Cedar Rapids Water Com^
pany t;. Cedar Rapids, 118
la. 234, 91 N. W. 1081, Octo-
ber 27, 1902.
§ 509, Depreciation.
551, 557, 569, Going concern.
736, Rate of return.
Central of Georgia Railway
Co. V. Railroad Conmiission of
Digitized by VjOOQ IC
Table of Cases Cited
XXIX
Alabama, 161 Fed. 925, March
21, 1908.
§ 747, Rate of return.
Central of Georgia Railway
Company v. Railroad Com-
mission of Alabama, no. 261,
in equity, United States Dis-
trict Court, Middle District of
Alabama, Northern Division,
Report of W. S. Thorington,
Special Master, January 8|
1912.
§ 192, Property donated
698, Franchise.
Central Yellow Pine Asso. v.
Illinois Central Ridlroad Com-
pany, 10 I. C. C. R. 505,
February 7, 1905.
§ 204, Surplus.
Chicago, Milwaukee & St.
Paul Ry. V. Minnesota, 134
U. S. 418, 10 Sup. Ct. 462, 33
L. ed. 970, March 24, 1890.
§ 3, Purpose of valuation.
Chicago Union Traction Co.
V. State Board of Equahzation,
114 Fed. 557, April 4, 1902.
§ 493, Depreciation.
715, Fninchise.
735, 792, 798, Rate of return.
City of. See name of city.
Clarion Turnpike & Bridge
Co. V. Clarion Coimty, 172
Pa. 243, 33 Atl. 580, January
6, 1896.
§ 668, Franchise.
Cleveland, Cincinnati, Chi-
cago & St. Louis Railway Com-
pany r. Backus, 154 U. S. 439,
14 Sup. Ct. 1122, 38 L. ed.
1041, May 26, 1894.
§ 524, Going concern.
Cleveland Railway Co., De-
cision of United States Dis-
trict Judge Robert W. Tayler
in the matter of the arbitra-
tion of the valuation of the
property of the Cleveland
Railway Company, Decem-
ber 16 and 17, 1909.
§ 191, Contributions by com-
pany.
244, Overhead charges.
324, Bond discount.
559, 569, Going concern.
710, Franchise.
Coal & Coke Railway Co. v.
Conley, 67 W. Va. 129, 67 S.
E. 613, March 8, 1910.
§ 105, Actual cost.
Columbus Railway and Light
Co. V. City of Columbus,
no. 1206, in equity. Circuit
Court of the United States,
Southern District of Ohio,
Eastern Division, Report of
Special Master T. P. Linn,
June 8, 1906.
§ 29, Fair value.
77, Cost of reproduction.
245, Overhead charges.
330, Bond discount.
552, 553, 569, Goin^ concem.
428, 497, Depreciation.
681, 699, Franchise.
743, 787, 797, Rate of return.
Consolidated Gas Co. v. City
of New York, 157 Fed. 849,
December 20, 1907.
§ 72, Cost of reproduction.
Ill, 119, 122, Land apprecia-
tion.
160, Pavement over mains.
344, 346, Working capital.
554, 569, 634, Gomg concem.
685, 687, 699, Franchise.
750, 798, Rate of return.
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XXX
Table of Cases Cited
Consolidated Gas Co. v. May-
er, 146 Fed. 150, June 8, 1906.
§ 683, Franohise.
Consolidated Gas Co. v. May-
er, Circuit Court of United
States, Southern District, New
York, Report of Arthur H.
Masten, Master ia Chancery,
May 18, 1907.
§ 119, Land appreciation.
160, Pavemoit over mams
254, Overhead charges.
344, Working capitaL
456, Depreciation.
553, Gomg ooncem.
684, Franchise.
Consolidated Gas Company
of Long Branch, In re, New
Jersey, July 25^ 1911, N. J.
Board of Public Utility Com-
missioners.
§ 253, Overhead charges.
Contra Costa Water Co. v.
City of Oakland, 166 Fed.
518, June 29, 1904.
§ 740, Rate of return.
Contra Costa Water Com-
pany V. City of Oakland^ 159
Cal. 323, 113 Pac. 668, Jan-
uary 19, 1911.
§ 566, 613, Going concern.
788, Rate of return.
Cornell Steamboat Company.
See People ex rel.
Cotting V. Kansas Citp Stock
Yards, 82 Fed. 850, October
28, 1897.
§ 23, Fair vahie.
Ill, Land.
Coving;i(»t and Lexington
Turnpike Road v. Sandford,
164 U. S. 678, 17 Sup. Ct.
198, 41 L. ed. 560, December
14, 1896.
§ 24, Fair, value.
784, Rate of return.
Cumberiand Telephone and
Telegraph Co. v. City of Louis-
viUe, 187 Fed. 637, April 25,
1911.
§ 33, Fair value.
98, Actual cost.
240, Overhead charges.
349, Working ea^ntal.
488, 505, Depreciation.
564, 569, Gomg concern.
693, 699v Franchise.
763, Rate of return.
Cumberland Telephone and
Telegraph Co. v. Railroad
Commission of Louisiana, 156
Fed. 823, August 27, 1907.
§ 744, Rate of return.
Darlington Electric Light and
Water Power Company, In re
Application of, 5 W. R. C. R.
397, June 17, 1910.
§ 211, Unused property.
Des Moines Gas Company v.
City of Des Moines, United
States Circuit Court, South-
em IXstrict of Iowa, Central
Division, Report of Robert R.
Sloan, SpeciaJ Master in Chaa*-
cery, April 4, 1912.
§ 569, Going eoncem.
Des Momes Water Company
V. City of Des Moines, no.
2468, in equity, Report of
George F. Henry, Master in
Chancery, United States Cir-
cuit Courts SoatheriL District
Digitized by VjOOQ IC
TabiiS op Casbb Citkd
of lewa, Central Division,
September 16, 1910:
§ I67y Pkveinent over mainfl^
216, UnuBed property.
245, Overhead ohari^
347, Wbridng capital.
498, Depreciaftion.
£62, 56^, Going eonoem.
^Des Moines Water ComfMOiy
t^. City gI Des Moines, 102
Fed. 193, September 16, 19IU
§ 167^ Pavement over mains.
562, Going concern.
770, Rate of retonw
Dow 9. Beidelman, 125 U. S.'
680, 8 Sup. Ct. 1028, 31 L. ed.
841, April 16, 1888.
§ 3, Purpose of valuation.
Falmouth v. Falmouth Water
Ca., 180 Mass. 325, 62 N. K
255, January 3, 1902.
§ 290, Overhead charges.
Fond du Lac Water Co., In
re, » W. R. a R. 482, An-
gust 19, 1910.
{ 164, PavemeBt ever maim.
612, Gomg ooflMem.
Galena Water Co. p. City of
Galena, 74 Kan. 624, 87 Pac.
736^ November 10, 1906.
§ 522, Going concern.
669, nanchise.
Gloucester Water Supply Cbu
V. Gloueester, 179 Mass. 366,
60 N. E. 977, June 19, 1901.
§ 527, 5ai,d38„5a6,.Ck>]iig;oon-
cem.
603, FnwdiiM*
Hill V. Antigo Water Com^
pany, 3 W. R. C. R. 623, Au-
gust 3, 1909.
f 7, 34, Ptamseelvaliialm.
2aO^UUtpnoew
§ 329, Bond diseount.
360, Pieoemeal construction.
427, Depreciation.
589, 601, 603, 612, 640, Going
concern.
689, FrBnchise.
Home Telephone Co. v. City
of Carthage, 235 Mo. 644, 139
S. W. 547, March 21, 1911.
§ 506, Depreciation.
694v 699, Franchise.
768^. Rate of return.
Illinois Central R. R. Co. v.
Interstate Commerce Com*
mission, 206 U. S. 441, 51 L.
ed. 1128, 27 Sup. Ct. 700,
May 27, 1987.
§ 204^ Surplus.
In re.
name.
See the particular
In the maitter of.
pMiticoiar name.
See the
Jamaica Water Supply Co.
See People ex rel.
Janesvilfe i>. JanesviBe Water
Co;, 7 W. R. C. R. 628, Au-
gust 17, 1911.
( 329, Bond diseount.
427, Depieciatdon.
005^ 612„ Goii% concern.
Kankauna Light and Power
Co., Re, 8- W. E. a R. 409,
December 26, 1911.
§ 612, Going cencem.
Kennebec Water District v.
City of Waterville, 97 Me.
185, 54 AtL 6, December 27,
1902.
§ 76, Cost of reproduction.
202^SacpIi]&
Digitized by VjOOQ IC
XODl
Table of Cases Cited
§ 533, 593, Going concern.
666, 669, Franchise.
795, Rate of retiim.
810, Appraisal rules.
Knoxville v. Knoxville Water
Company, 212 U. S. 1, 29 Sup.
Ct. 148, 53 L. ed. 371, Janu-
ary 4, 1909.
§ 38, Fair value.
72, Cost of reproduction.
299, Overhead charges.
431, 432, 462, 484, 510, De-
preciation.
535, 555, 556, 565, 569, Going
concern.
752, 761, 784, 790, Rate of re-
turn.
Knoxville Water Co. t;. City
of Knoxville, no. 1260, in
equity, Circuit Court of the
United States, Eastern Dis-
trict of Tennessee, Northern
Division, Report of Henry O.
Ewing, Special Master, Au-
gust 19, 1904.
§ 431, Depreciation.
Knoxville Water Co. i;. City
of Knoxville, no. 1260, in
equity. Circuit Court of the
United States, Eastern Dis-
trict of Tennessee, Northern
Division, Opinion of Circuit
Judge Clark, January 24, 1905.
§ 431, Depreciation.
La Crosse Gas and Electric
Company, In re, 8 W. R. C.
R. 138, November 17, 1911.^
§ 163, Pavement over mains.
211, Unused property.
343, Working capital.
464, Depreciation.
606, 610, Going concern.
lincohi Gas and Electric Light
Co. V. City of Lincob, 182
Fed. 926, April 6, 1909.
§ 72, Cost of reproduction.
247, 291, Overhead charges.
331, Bond discount.
348, Working capital
688, 699, Franchise.
755, Rate of return.
Lincoln Gas pud Electric Light
Co. V. City of Lincoln, 223 U.
S. 349, February 19, 1912.
§ 72, Cost of reproduction.
331, Bond discount.
348, Working capital.
482, 510, Depreciation.
688, Franchise.
755, Rate of return.
Lincoln Traction Company,
In the Matter of the Applica-
tion of, Nebraska State Rail-
way Conamission, May 17,
1911.
§ 765, 797, Rate of return.
Local Merchandise Rates of
the Express Companies in the
State of Indiana, no. 495,
Railroad Conmiission of In-
diana, January 31, 1912.
§ 7, Purpose of valuation.
Long Branch Commission v.
Tintem Manor Water Com-
pany, 70 N. J. Eq. 71, 62 Atl.
474, November, 1905.
§ 217, Unused property.
291, Overhead charges.
.742, Rate of return.
Long Island Water Supply Co.
See Brooklyn, In Matter of
aty of,
Louisiana Railroad Commis-
sion V. Cumberland Telephone
and Telegraph Company, 212
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Table of Cases Cited
xxxiii
U. S. 414, 29 Sup. a, 357, 53
L, ed. 577, February 23, 1909.
§ 200, Surplus.
424, 458, Depreciation.
744, Rate of return.
Louisville and Nashville Rail-
road Company v. Brown, 123
Fed. 946, June 30, 1903.
§ 738, Rate of return.
Louisville and Nashville Rail-
road Company v. Railroad
Conmiission of Alabama,
United States Circuit Court,
Middle District of Alabama,
Report of WUUam A. Gunter,
Special Master in Chancery,
1911.
§ 698, Franchise.
Louisville and Nashville Riul-
road Co. v. Siler, 186 Fed. 176,
January 9, 1911.
§ 787, Rate of return.
Manhattan Ry. Co. v. Wood-
bury. See People ex rel. Man-
hattan Ry. Co. V. Woodbury.
Manitowoc Water Works Co.,
In re, 7 W. R. C. R. 71,
June 27, 1911.
§ 11, Purpose of valuation.
34, Fair value.
164, Pavement over mains.
212, Unused property.
230, Unit price.
612, Qoing concern.
Marinette v. City Water Co.,
8 W. R. C. R. 334, December
14, 1911.
§ 329, Bond discount.
605, 612, Going concern.
Matthews v. Board of Corpo-
ration Conunissioners of North
Carolina, 106 Fed. 7, Febru-
ary 5, 1901.
I 63, Market value.
Mayhew v. Kings Co. Light-
mg Co., 2 P. S. C. Ist D. (N.
YO — , October 20, 1911.
§ 11, Purpose of valuation.
107, Actual cost.
122, Land appreciation.
168, Pavement over miuns.
214, Unused prop^y.
255, 296, Overhead charges.
345, Working capital.
487, Depreciation.
567, 569, 590, Going concern.
697, Franchise.
772, 792, Rate of return.
Menominee and Marinette
Light and Traction Co., In
re, 3 W. R. C. R. 778, de-
cided August 3, 1909.
§ 34, Fair value.
Mercantile Trust Co. v. Texas
& P. Ry. Co., 51 Fed. 529,
August 23, 1892.
§ 375, Adaptation and solidifi-
cation.
Metropolitan Street Railway
Reorganization, In re, 3 P.
S. C. Ist D. (N. Y.) 113,
February 27, 1912,
§ 145, Land.
289, 296, 302, Overhead
charges.
380, Adaptation.
402, 405, 433, 495, Deprecia-
tion.
Metropolitan Trust Co. v.
Houston & T. C. R., 90 Fed.
683, December 1, 1898.
§ 62, Market value.
375, Adaptation and solidifi-
cation.
450, 569, 613, Going concern.
Digitized by VjOOQ IC
XXXIV
Table of Cases Cited
Meyers Co.
Co.
See S. F. Meyers
MifBin Bridge Company v,
Juniata County, 144 Pa. 365,
22 Atl. 896, 13 L. R. A. 431,
October 5, 1891.
§ 668, Franchise.
Milwaukee Electric Railway
& Light Co. V. City of Mil-
waukee, 87 Fed. 477, May 31,
1898.
§ 461 , Depreciation.
734, Rate of return.
Minneapolis, St. P. & S. S.
M. R. Co. V, Railroad Com-
mission of Wisconsin, 136 Wis.
146, 116 N. W. 905, 17 L. R.
A. (N. S.) 821, June 5, 1908.
§ 790, Rate of return.
Missouri, K. and T. Ry. Co.
V. Love, 177 Fed. 493, Febru-
ary 14, 1910.
§ 376, Adaptation and solidifi-
cation.
561, 569, Going concern.
Monheimer v. Brooklyn Union
Elevated Railroad Company,
2 P. S. C. 1st D. (N. Y.) — ,
March 8, 1910.
§ 187, Property donated.
Monheimer v. Coney Island
and Brooklyn Railroad Co.,
1 P. S. C. 1st D. (N. Y.) — ,
July 2, 1909.
§ 403, Depreciation.
Monoi^ahela Navigation
Company v. United States,
148 U. S. 312, 13 Sup. Ct. 622,
37 L. ed. 463, March 27, 1893.
§ 11, Purpose of valuation.
662, 680, 685, Franchise.
Monongahela Water Com-
pany, In re, 223 Pa. State, 323,
72 Atl. 625, January 4, 1909.
§ 534, Going concern.
668, 669, Franchise.
Montgomery Coimty v.
Schuylkill Bridge Co., 110
Pa. State, 54, 20 Atl. 407,
May 25, 1885.
§ 660, 668, Franchise.
Munn V. Illinois, 94 U. S. 113,
24 L. ed. 72, October, 1876.
§ 3, Purpose of valuation.
National Water Works Com-
pany V. Kansas City, 62 Fed.
853, 10 C. C. A. 653, 27 L. R.
A. 827, 27 U. S. App. 165,
July 2, 1894.
§ 520, 521, 522, 523, 525, 527,
530, 532, 533, 535, 536,
553, 555, Gk)ing con-
cern.
New York and New England
Railroad Company v. Town
of Bristol, 151 U. S. 556, 14
Sup. Ct. 437, 38 L. ed. 269,
February 5, 1894.
§ 189, Property donated.
New York and North Shore
Traction Co., In re Bond
Issue of, 3 P. S. C. 1st D. (N.
Y.) 63, February 13, 1912.
§ 380, Adaptation.
New York, Ontario and West-
em Railway Co. See People
ex rel.
Newburyport Water Com-
pany V, City of Newburyport,
168 Mass. 541, 47 N. E. 533,
June 14, 1897.
§ 525, 533, 536, Going concern.
663, Franchise.
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Table of Cases Cited
XXXV.
Northern Pacific Railway Co.
V. Minnesota ex rel. Duluth,
208 U. S. 583, 28 Sup. a. 341,
52 L. ed. 630, February 24,
1908.
§ 189, Property donated.
Norwich Gas and Electric Co.
V. City of Norwich, 76 Conn.
565, 57 Atl. 746, April 14,
1904.
§ 531, 536, Going concern.
665, Franchise.
Oconto City Water Supply
Co., In re Application of the,
7 W. R. C. R. 497, August 7,
1911.
§ 608, 609, 612, Going concern.
Omaha v, Omaha Water Com-
pany, 218 U. S. 180, 30 Sup.
Ct. 615, 54 L. ed. 991, May 31,
1910.
§ 11, Purpose of valuation.
535, 536, 567, 568, 569, Going
concern.
Owensboro v. Cumberland
Telephone & Telegraph Co.,
174 Fed. 739, 99 C. C. A. 1,
December 14, 1909.
§ 758, Rate of return.
Paulhamus r. Puget Sound
Electric Railway, Railroad
Commission of Washington,
February 26, 1910, no. 76
(Fifth Annual Report, 1910,
p. 17).
§ 52, Market value.
259, 281, 287, Overhead
charges.
328, Bond discount.
371, Solidification.
Pa3rne v. Wisconsin Telephone
Co., 4 W. R. C. R. 1, August 3,
1909.
§ 486, Depreciation.
612, 635, Going concern.
Pennsylvania Railroad Co. v.
Philadelphia County, 220 Pa.
St. 100, 68 Atl. 676, 15 L. R.
A. (N. S.) 108, January 20,
1908.
§ 746, 795, Rate of return.
People V. O'Brien, 111 N. Y.
1,18N.E.692,2L.R.A.255,
7 Am. St. Rep, 684, Novem-
ber 27, 1888.
§ 685, Franchise.
People ex rel. Brooklyn
Heights Railroad Co. v. Tax
Commissioners, 69 Misc. (N.
Y.) 646, 127 N. Y. Supp. 825,
December, 1910.
§ 491, Depreciation.
720, Franchise.
People ex rel. Cornell Steam-
boat Company v. Dederick,
161 N. Y. 195, 55 N. E. 927,
January 9, 1900.
§ 553, Going concern.
People ex rel. Jamaica Water
Supply Co. V, Tax Commis-
sioners, 128 App. Div. (N. Y.)
13, 112 N. Y. Supp. 392,
September 17, 1908.
§ 489, Depreciation.
People ex rel. Jamaica Water
Supply Company v. Tax Com-
missioners, 196 N. Y. 39, 89
N. E. 581, October 19, 1909.
§ 489, Depreciation.
713, Franchise.
756, Rate of return.
People ex rel. Manhattan Rail-
way Co. V. Woodbury, 203
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XXXVl
Table of Cases Cited
N. Y. 231, 96 N. E. 420,
October 17, 1911.
§ 350, Working capital.
490, 491, Depreciation.
713, Franchise.
771, Rate of return.
People ex rel^ New York, On-
tario & Western Railway Com-
pany V. Shaw, 143 App. Div.
(N. Y.) 811, 128 N. Y. Supp.
177, March 8, 1911.
§ 139, Railroad right of way.
291, Overhead charges.
378, Solidification.
People ex rel. Queens County
Water Company v. Woodbury,
67 Misc. (N. Y.) 490, 123 N.
Y. Supp. 599, May 20, 1910.
§ 491, Depreciation.
714, Franchise.
People ex rel. Third Avenue
R. R. Co. V. Tax Conmiis-
sioners, 136 App. Div. 155,
120 N. Y. Supp. 528, Decem-
ber 30, 1909; affirmed, 198
N. Y. 608, 92 N. E. 1098,
May 10, 1910.
§ 491, 494, Depreciation.
Pioneer Telephone and Tel-
graph Co. V. Westenhaver, 29
Okl. — , 118 Pac. 354, Janu-
ary 10, 1911.
§ 32, Fair value.
72, Cost of reproduction.
256, 285, 293, Overhead
charges.
361, Piecemeal construction.
432, 504, Depreciation.
565, 569, 613, Gomg concern.
760, Rate of return.
Puget Soimd Electric Railway
V. Railroad Commission, 64
Wash. — , 117 Pac. 739, Sep-
tember 16, 1911.
§ 484, Depreciation.
769, Rate of return.
Queens Borough Gas and Elec-
tric Company, In re, 2 P. S.
C. 1st D. (N. Y.) — , June 23,
1911.
§ 11, Purpose of valuation.
122, Land appreciation.
205, Surplus.
214, Unused property.
299, Overhead charges.
455, 483, 487, Depreciation.
567, 568, Going concern.
796, 797, Rate of return.
Queens County Water Com-
pany. See People ex rel.
Racine v. Racine Gas Light
Company, 6 W. R. C. R. 228,
January 27, 1911.
§ 163, Pavement over mains.
216, Unused prop^y.
427, Depreciation.
611, 612, Going concern.
Railroad Conunission Cases,
116 U. S. 307, 6 Sup. Ct. 334,
29 L. ed. 636, January 4, 1886.
§ 3, Purpose of valuation.
Re. See the particular name.
Reagan v. Farmers' Loan and
Trust Co., 164 U. S. 362, 14
Sup. Ct. 180, 38 L. ed. 1014,
May 26, 1894,
§ 11, Purpose of valuation.
21, Fair value.
60, Market value.
731, 784, Rate of return.
Ripon V. Ripon Light and
Water Company, 5 W. R. C.
R. 1, March 28, 1910.
§ 143, Termmal land.
163, Pavement over mains.
Digitized by VjOOQ IC
Table op Cases Cited
xxxvii
§ 184, Property donated.
262, 280, Overhead charges.
360, Piecemeal constnictioii.
Rochester^ Coming, Elmira
Traction Co., In re, 1 P. S.
C. 2d D. (N. Y.) 166, March
30, 1908.
§ 301, Overhead charges.
341, Working capit^.
S. F. Meyers Co. t;. Tuttle,
188 Fed. 632, June 14, 1911,
§ 632, Going concern.
St. Louis & S. F, R. Co. v.
Hadley, Atty. Gen. of Mo.,
168 Fed. 317, March 8, 1909.
§ 9, Purpose of valuation.
754, Rate of return.
Salem Gas Light Company,
In the Matter of, New Jersey
Board of Public Utility Com-
missioners, November 8, 1911.
§ 429, Depreciation.
San Diego Land and Town Co.
V. Jasper, 110 Fed. 702, Au-
gust 26, 1901.
§ 22, Fair value.
San Diego Land and Town Co.
V. Jasper, 189 U. S. 439, 23
Sup. Ct. 671, 47 L. ed. 892,
April 6, 1903.
§ 26, 36, Fair value.
72, Cost of reproduction.
216, Unused property.
510, Depreciation.
San Diego Land and Town
Co. 9. National City, 74 Fed.
79, May 4, 1896.
f 22, Fair value.
72, Cost of reproduction.
San Diego Land and Town
Company v. National Qty,
174 U. S. 739, 19 Sup. Ct. 804,
43 L. ed. 1164, May 22, 1899.
§ 25, 26, 36, Fair value.
72, Cost of reproduction.
Ill, Land.
San Diego Water Company
V. aty of San Diego, 118 Cal.
566, 60 Pac. 633, October 9,
1897.
§ 11, Purpose of valuation.
61, Market value.
103, Actual cost.
182, Property donated.
507, Depreciation.
680, Franchise.
732, Rate of return.
San Joaquin and Kings River
Canal & Irrigation Company
V. Stanislaus County, 163 Fed.
567, June 29, 1908.
§ 430, Depreciation.
739, Rate of return.
San Joaquin and Kings River
Canal & Irrigation Company
V. Stanislaus Coimty, 191 Fed.
875, September 18, 1911.
§ 183, Property donated.
379, Solidification.
502, Depreciation.
569, Going concern.
695, 699, Franchise.
Saratoga Springs v. Saratoga
Gas, Electric Light, Heat and
Power Co., 122 App. Div. (N.
Y.) 203, 106 N. Y. Supp. 1148,
November 20, 1907.
§ 745, 798, Rate of return.
Savannah & Suburban Street
Railway Improvement Asso-
ciation V. Savannah Electric
Company, Georgia Railroad
Commission, January 6 1912.
§ 496, Depreciation.
696, 699, Franchise.
Digitized by VjOOQ IC
XXXVIU
Table of Cases Cited
Shepard v. Northern Pacific
Railway Co., in equity, Re-
port of Chas. E. Otis, Special
Master in Chancery, United
States Circuit Court, District
of Minnesota, Third Division,
September 21, 1910.
§ 136, Railroad right of way.
141, 142, Terminal load.
148, Land appraisal methods.
182, Property donated.
322, Bond discount.
Shepard v. Northern Pacific
Railway Co., 184 Fed. 765,
April 8, 1911.
§ 71, Cost of reproduction.
117, Land appreciation.
136, Railroad right of way.
142, Terminal land.
186, Property donated.
292, Overhead charges.
332, Bond discount.
377, Adaptation and solidifi-
cation.
762, Rate of return.
Smyth V. Ames, 169 U. S. 466,
18 Sup. Ct. 418, 42 L. ed. 819,
March 7, 1898.
§ 3, Purpose of valuation.
24, 31, 36, 38, Fair value,
52, 53, Market value.
72, Cost of reproduction.
Ill, Land.
685, Franchise.
784, 786, Rate of return.
South and North Alabama
Railroad Company v. Railroad
Conmiission of Alabama,
United States Circuit Court,
Middle District of Alabama,
Report of William A. Gimter,
Special Master in Chancery,
1911.
§ 698, Franchise.
Spokane v. Northern Pacific
Railway Company, 15 I. C.
C. R. 376, February 9, 1909.
§ 118, Land appreciation.
203, Surplus.
753, 797, Rate of return.
Spring VaUey Water Co. r.
San Francisco, 165 Fed. 667,
October 7, 1908.
§ 7, Purpose of valuation.
72, 78, Cost of reproduction.
215, Unused property.
563, 566, 614, Going concern.
690, 699, Franchise.
748, 789, Rate of return.
Spring Valley Water Works r.
San Francisco, 124 Fed. 574,
June 29, 1903.
§ 11, Purpose of valuation. .
27, Fair value.
663, 569, Going concern.
680, 699, Franchise.
737, 740, Rate of return.
Spring Valley Water Works «.
San Francisco, 192 Fed. 137,
October 21, 1911.
§ 11, Purpose of valuation.
35, Fair value.
56, 59, Market value.
215, Unused property.
501, Depreciation.
663, 569, 591, 614, 634, Going
concern.
691, 699, Franchise.
766, Rate of return.
Spring Valley Water Works v.
Schottler, 110 U. S. 347, 4
Sup. Ct. 48, 24 L. ed. 173,
February 4, 1884.
§ 3, Purpose of valuation.
Stanislaus County v. San Joa-
quin and Kings River Canal
and Irrigation Co., 192 U. S.
201, 26 Sup. a. 241, 48 L. ed.
406, January 18, 1904.
§ 28, Fair value.
739, 761, 784, Rate of return.
Digitized by VjOOQ IC
Table op Cases Cited
xxxix
State ex rel. Bee Building
Company v. Savage, 65 Neb.
714, 91 N. W. 716, September
18, 1902.
§ 8, Purpose of valuation.
State ex rel. City of Min-
neapolis V. St. P., M. and Man-
itoba R. R, Co., 98 Minn.
380, 108 N. W. 261, June 29,
1906.
§ 189, Property donated.
State Journal Printing Com-
pany V. Madison Gas and
Electric Company, 4 W. R. C.
R. 501, March 8, 1910.
§ 34, Fair value.
113, Land appreciation.
146, 147, Land appraisal
methods.
163, Pavement over mains.
294, Overhead charges.
343, Workmg capital.
360, Piecemeal construction.
486, Depreciation.
602, 603, 612, Going concern.
791, 797, Rate of return.
Steenerson v. Great Northern
Railway Company, 69 Minn.
353, 72 N. W. 713, October 20,
1897.
§ 71, Cost of reproduction.
120, Land appreciation.
181, Property donated.
733, Rate of return.
Third Avenue Railroad Co.,
In re Amortization Accounts
of,3P.S.C. IstD. (N.Y.)51,
February 3, 1912.
§ 322, Bond discount.
495, Depreciation.
Third Avenue Raiboad Co.,
In re Reorganization of, 2
P. S. C. Ist D. (N. Y.) — ,
July 29, 1910.
f 289, Overhead charges.
§ 433, 463, Depreciation.
615, Going concern.
Tighe V. Clmton Telephone !
Company, 3 W. R. C. R. 117, \
December 2, 1908.
§ 183, Property donated.
Union Pacific R. R. Co. i;.
United States, 99 U. S. 402,
25 L. ed. 274, October, 1878
§ 204, Surplus.
Venner Co. See C. H. Venner
Co.
Washburn v. National Wall
Paper Co., 81 Fed. 17, 26 C.
C. A. 312, May 26, 1897.
§ 553, 554, 632, Going concern.
Washburn v. Washburn Water
Works Co., 6 W. R. C. R. 74,
December 6, 1910.
§ 184, Property donated.
West Chester & W. Plank
Road Co. V. County of Ches-
ter, 182 Pa. 40, 37 Atl. 905,
July 15, 1897.
§ 668, Franchise.
Western of Alabama Railway
Company v. Railroad Com-
inission of Alabama, no. 265,
in equity. United States Dis-
trict Court, Middle District
of Alabama, Northern Divi-
sion, April 3, 1912.
§ 192, Property donated.
698, Franchise.
Whitewater v. Whitewater
Electric Light Co., 6 W. R. C.
R. 132, December 16, 1910.
§ 427, Depreciation.
Wilkesbarre v. Spring Brook
Digitized by VjOOQ IC
xl Table of Cabbs Cited
Water C!o., 4 Lack. (Pa.) Leg. § 72, Cost of reproduction.
News, 367 (1899). 112, Land appreciation.
§ 104, Actual cost. 161, Pavement over mains.
192, 53 L. ed. 382, January 4, 686, 687, 688, 691, 695, 699,
1909. Franchise.
§ 7, 11, Purpose q/1 valuation. 751, 754, 761, 784, 798, Rate
30, 36, 38, Fair value. of return.
Digitized by VjOOQi^
CHAPTER I
Purpose of Valuation
I 1. Purposes of valuation.
2. Valuation for public purchase.
3. Valuation for rate purposes.
4. Valuation dependent on purpose.
5. Same subject — Report of Committee National Association of Rail-
way Conunissionera.
6. Same subject — ^Report to Massachusetts Joint Board on N. Y., N.
H. & H. R. R.
7. Value for taxation and for rate purposes.
8. Tax and rate purpose — Nebraska Supreme Court in Bee Building
Co. Case, 19Q2.
9. Tax and rate purpose — District Judge McPherson in St. Louis A
S. F. R. Co. Rate Case, 1909.
10. Tax and rate purpose — Arkansas Railroad Rate Cases, 1911.
11. Value for rate purpose and for public purchase.
12. Capital value and rate and purchase value.
§ 1. Purposes of valuation.
This treatise is concerned only with valuations made
for govenynental purposes by official appraisers, commis-
fiions or courts. Ofl&cial valuations of the property of pub-
lic service corporations are made for four general purposes :
(1) Taxation; (2) Accounting and capitalization; (3) Public
purchase; (4) Rate making. Valuations for tax and cap-
italization purposes are only included in so far as they
may throw light on the problems raised by valuation for
the last two purposes, rate making, and public purchase,
to which this treatise is mainly devoted.
§ 2. Valuation for public purchase.
There have been numerous valuations of pubUc utility
property for purposes of condemnation or public purchase
but there is very little information available in relation to
Digitized by VjOOQ IC
2 Valuation [§ 3
the methods used in such valuations. In the earlier days
toll bridges were occasionally taken by condemnation or
purchased on agreed terms. Later, nimierous private water
plants were transferred to the municipalities, usually by
voluntary agreement but occasionally by formal arbitra-
tion, under the authority of a court. Several gas plants
have been municipalized in the same way. Many small
electric light plants and a munber of larger ones have more
recently been purchased by the municipalities. The pur-
chase of private water plants is still a frequent occur-
rence.
§ 3. Valuation for rate purposes.
The valuation of property for rate purposes is a recent
development. The right of the courts to restrain the en-
forcement of an act of a legislature regulating the rates of a
public service corporation was not fully established by the
United States Supreme Court until 1889, and careful valu-
ations for the purpose of determining just rates of charge
have for the most part been developed since the decision in
the leading case of Smyth v. Ames in 1898. The question of
rate regulation first came before the United States Supreme
Court in the so-called Granger Cases decided in 1876.*
In these cases the acts in question regulating rates were
upheld on the ground that the property was afifected with a
public interest and the regulation of the rate of charge was
solely a legislative power and the courts were powerless
to prevent the abuse of such power by the legislature.
This doctrine was soon modified and later completely
reversed. In 1884, in Spring Valley Water Works v.
Schottler,^ Chief Justice Waite hinted at a modification
of the doctrine, and in 1886, in the Railroad Commission
» Munn V. Illinois, 94 U. S. 113, 24 L. ed. 72, October, 1876, and other
cases reported in the same volume. See, also, Wyman on Public Service
Corporations, Vol. II, §§ 1427 to 1430.
« 110 U. S. 347, 4 Sup. Ct. 48, 24 L. ed. 173, Febmaiy 4, 1884.
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§ 4] Purpose 3
cases,' Chief Justice Waite remarked: "It is not inferred
that this power of limitation or regulation is itself without
limit. This power to regulate is not a power to destroy,
and limitation is not the equivalent of confiscation/' In
1888, however, in Dow v. Beidelman,* Justice Gray said:
"The court has no means, if it would under any circum-
stances have the power, of determining that the rate of
three cents a mile fixed by the legislature is unreason-
able." Nevertheless, in 1889, in Chicago, Milwaukee
& St. Paul Railway v. Minnesota,^ the court held that
it is necessarily within the power of the courts to declare
illegal and unreasonable a rate fixed by a legislature or
commission. However, it was not imtil 1898, in the lead-
ing case of Smyth v. Ames,* that it was clearly decided
that a fair return on the fair value of the property used
for the convenience of the pubUc was the chief basis for
the determination of the reasonableness and the con-
stitutionality of a rate.
§ 4. Valuation dependent on purpose.
A fundamental question is whether the identical valua-
tion can serve for all of the four general purposes (see § 1)
for which public valuations are made. Is valuation the
same regardless of the purpose or is valuation meaningless
unless used with reference to some specific purpose? Upon
the answer to this question depends the use that can be
made of precedents concerning the rules and elements of
valuation as laid down by courts and conunissions. As a
matter of fact the courts and commissions in their opinions
» 116 U. S. 307, 331, 6 Sup. Ct. 334, 29 L. ed. 636, January 4, 1886.
These cases, reported under the title of, and cited as "Railroad Commission
Cases," are: Stone et al. v. Farmers' Loan & Trust Company, Stone et al.
V, Illinois Central Railroad Company, Stone et al. v. New Orleans & North-
eastern Railroad Company.
• 125 U. S. 680, 8 Sup. Ct. 1028, 31 L. ed. 841, April 16, 1888.
• 134 U. S. 418, 10 Sup. Ct. 462, 33 L. ed. 970, March 24, 1890.
• 169 U. S. 466, 18 Sup. Ct. 418, 42 L. ed. 819, March 7, 1898.
Digitized by VjOOQ iC
4 Valuation [§ 5
often recognize that valuation or specific elements of valu-
ation may vary with the purpose. The best-considered de-
cisions ate undoubtedly those in which the problem of
valuation has been worked out solely with reference to
what was just and reasonable, with reference to the spe-
cific purpose for which the valuation was made. The
result has sometimes been less fortunate when the reason-
ing has been influenced by the fact that because it was
just and reasonable to adopt a particular rule in a valu-
ation for a different purpose it was consequently proper
to adopt the same rule for the purpose at hand.
§ 6. Same subject — Report of Committee National Associa-
tion of Railway Commissioners.
This subject is treated in the 1911 report of the Valu-
ation Committee of the National Association of Railway
Commissioners : ^
Prior discussions of valuation both within and outside of this
association have usually maintained that valuation should be the
same regardless of the purpose for which the valuation is to be
used. How, for example, can a State commission recognize four
different kinds of value and make one valuation for municipal
purchase, another for taxation, another for rate making, and
another for capitalization? To do so seems at first thought in-
consistent. On the other hand, a little consideration will show
that value is meaningless unless made with reference to some
particular object. To be sure, it may happen that fair value
for one purpose is the same as fair value for another, but in
order to determine what is fair value for any specific purpose,
it is necessary to think it out with reference to this purpose
only, and when we discuss the theory and elements of valua-
tion, it seems necessary that we should have in mind a specific
purpose that the valuation is to serve. It appears to us that
considerable confusion in the discussion of the subject of val-
^ National Association of Railway Commissioners, Proceedings of the
23d Annual Convention, October, 1911, p. 145.
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§ 6] Purpose 5
uation has arisen either from lack of attention to this fact or
from the false assumption that value may be ascertained with-
out reference to purpose.
Some of the trouble doubtless arises from a confusion of the
terms "cost" and "value." Cost is a definite amount regard-
less of purpose. The actual cost and the reproduclion cost of
any structure may be determined without reference to the pur-
pose for which such estimates may later be used. This is what
is often meant when it is said that valuation should be the same
regardless of purpose. All that is really intended is that actual
cost or reproduction cost should be the same. But cost is not
necessarily value for any purpose, though it is an element in
estimating fair value for almost any purpose. Thus fair value
for rate purposes may be based largely on actual cost or on re-
production cost or on a composite of actual cost and reproduc-
tion cost. Considerations of equity may, as to certain elements
of cost, lead to the acceptance of actual cost as the fairer basis,
while as to other elements the cost of reproduction may be a
better indication of present fair value for rate purposes. Take
for example the question of promotion and other preUmi-
nary development costs. In a valuation for rate purposes,
though cost of reproduction may be used as a general rule, it may
seem more equitable to use actual cost of promotion; that is,
the necessary cost of promoting the small initial plant, rather
than the cost to-day of promoting a plant of the size of the
present one, may be taken. Or, on the other hand, promotion
cost may be entirely excluded from a valuation for rate pur-
poses and considered only in fixing the fair rate of return.
§ 6. Same subject — Report to Massachusetts Joint Board on
N. Y., N. H. & H. R. R.
George F. Swain, Engineer in Charge of Appraisal, in
his report to the Massachusetts Joint Board on the vali-
dation of assets and liabilities of the New York, New
Haven & Hartford Railroad Company,* states that the
' Published in Report of the Mafisachusetts Joint Commission on the
New York, Now Haven <fe Hartford Railroad Company, February 15,
1911, pp. 51-154.
Digitized by VjOOQ IC
6 Valuation [§ 6
physical valuation of a property may be undertaken for
any one of a number of different purposes, and that the
principle upon which such a valuation should be made will
differ according to which purpose is in view. Mr. Swain
says (at page 55) :
1. Whether the physical valuation is a proper basis for tax-
ation will depend upon the tax laws. . . .
2. Physical valuation does not, in general, appear to be a
fully adequate basis for justifying existing capital, for such
capital generally depends upon the historical development of
the property, and some or much of it may represent property
which has been abandoned, or machinery whicfrhas been made
useless, by necessary relocations, or by improvements in me-
chanical appliances. . . .
3. Neither is a physical valuation a fair criterion for justi-
fying or not justifying the further issue of securities. If actual
improvements are needed upon a railway property in order
to enable it to render proper service, or in order to effect
operating economies, it would seem that new capital to meet
those requirements should be authorized, independent of the
existing capital. . . .
4. If the physical valuation is to be used for the purpose
of aiding in fixing rates for service, earning power is not to be
considered. Rates and earning power are interdependent, and
one cannot be considered an element in fixing the other. . . .
5. The physical valuation is not a scientific basis for an es-
timate of the public wealth, because that wealth depends
upon the value of the property as a "going" concern, and this
depends upon its earning capacity, not its physical valua-
tion. . . .
6. The treatment of depreciation, and of abandoned property
in particular, should reasonably differ according to the purpose
of the appraisal. . . .
If the object is to justify existing capital, or to serve as a
basis for the issue of new securities, or to fix rates of service,
it seems reasonably clear, however, that depreciation should
not be allowed for.
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§ 7] Purpose 7
§ 7. Value for taxation and for rate purposes.
As to the relation between valuation for taxation and
valuation for rate purposes, the Valuation Committee
of the National Association of Raibroad Commissioners
says:*
There is no inherent inconsistency in using one method of
valuation for tax purposes and another method for rate pur-
poses. The tax, by whatever method assessed, is considered
an operating expense in fixing rates, and is therefore borne by
the user of the service wherever rates of charge are strictly
regulated. Methods of ad valorem taxation must be worked
out with an eye single to what is just and practicable in taxa-
tion, and methods of valuation for rate purposes must be
worked out with an eye single to what is just and constitu-
tional in rate making.
Substantially the same position is taken by the Rail-
road Commission of Indiana in a case entitled In the
Matter of Local Merchandise Rates of the Express Com-
panies in the State of Indiana, No. 495, January 31, 1912.
In Indiana, express companies are taxed on the so-called
unit rule on the entire value of their property as a going
concern. In the above case the companies claimed that
they were entitled to a fair return on the tax value of
their property in the State of Indiana, but Commissioner
Wood in delivering the opinion of the Commission
states that tax value and fair value for rate purposes may
be entirely different. He says:
With reference to taxation values in the State of Indiana,
we hold that this is not the value upon which the carriers can
claim a rate. We hold that they are entitled to earn and to
pay to the State whatever assessment is made against them,
no matter on what method the assessment may be made, and
that the amount paid must be allowed to them just as the cost
'National Association of Railway Commissioners, Proceedings of the
23d Annual Convention, October, 1911, p. 148.
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8 Valuation [§ 7
of operation is allowed to them, but on the other hand the taxa-
tion value is not the value upon which to base the rate, but the
rate must be based upon the amount which they have invested,
and not otherwise.
In Spring Valley Water Co. v. San Francisco, 165 Fed.
667, 696, decided Oct. 7, 1908, District Judge Farrington
says:
The argument that the franchise ought to be worth some-
thing for rate-fixing purposes if it is worth millions for taxa-
tion is not without force. The value fixed by the assessors,
however, is not admissible as evidence of value in condemna-
tion proceedings. Lewis on Eminent Domain, §448. And
such evidence is of little worth here. If the aggregate value
of the franchise and physical property as assessed did not ex-
ceed the total valuation for water rates, the company suffered
no injustice.
In Willcox V. Consolidated Gas Company, 212 U. S.
19, 61, 29 Sup. Ct. 192, 63 L. ed. 382, decided Jan. 4,
1909, the United States Supreme Court rejected the com-
pany's claim that the tax value of special franchises
should control their value for rate purposes, saying:
The fact that the State has taxed the company upon its
franchises at a greater value than is awarded them here, is
not material. Those taxes, even if founded upon an erroneous
valuation, were properly treated by the company as part of
its operating expenses, to be paid out of its earnings before
the net amount could be arrived at applicable to dividends,
and if such latter sums were not sufficient to permit the proper
return on the property used by the company for the public,
then the rate would be inadequate. The future assessment of
the value of the franchises, it is presumed, will be much les-
sened if it is seen that the great profits upon which that value
was based are largely reduced by legislative action. In that
way the consumer will be benefited by paying a reduced sum
(although indirectly) for taxes.
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§ 7] Purpose 9
The Wisconsin Railroad Commission, in Hill v. Antigo
Water Co., 3 W. R. C. R. 623, 728, decided August 3,
1909, follows the same reasoning as the United States
Supreme Court in the Consolidated Gas Case, say-
ing:
Public utilities, like other property, are supposed to be taxed
upon their earning or market value. This assessment is made
annually. The market value depends very largely upon the
net earnings of an enterprise, and the net earnings, in turn, to a
considerable extent rest upon the rates charged per unit for the
services rendered. When the rates are increased, there is apt
to be increase in the net earnings and in the market or assessed
valuation. When the rates are reduced, the net earnings, to-
gether with the values named, are also apt to be reduced. There
is thus a rather close relation between the assessed valuation
and the rates. If utilities are permitted to charge high rates
and thereby increase their net earnings or market value, it
would seem to be only fair that they should also be required to
pay taxes on the higher valuation. On the other hand, if the
rates and the net earnings and market value are reduced, cor-
responding reductions should also be made in the assessed val-
uation. This is precisely what takes place. The assessments
for taxation are changing with the net earnings or with market
values. This practice would seem to be fair and to be in line
with public policy. Since the assessment for taxation thus
varies with the rates, it is difficult to see on what just grounds
the state should be compelled to use the same valuation for
rate-fixing purposes as that upon which taxes are levied.
There is no authority for the doctrine that an appraisal
for taxation is necessarily a proper valuation for rate
purposes. Tax laws dififer widely and the bases of ap-
praisal are many. It is needless to say that precedents
as to appraisal for tax purposes are of no importance in
considering valuations for public purchase, rate making
or capitalization. It may be that when the method
of valuation for rate purposes has become clearly and
Digitized by VjOOQ IC
10 Valuation [§ 8
authoritatively defined it may seem just and practicable
to adopt it also as the basis for taxation. But until that
time comes talk of a common valuation is futile. The
basis of taxation can be fixed by the legislature but the
basis of a just and reasonable valuation for rate purposes
or for condemnation purposes can only be worked out
in the last instance by the Supreme Court of the United
States. In view of these facts valuation for tax purposes
is not included in this treatise.
There are a few cases, however, quoted in the fol-
lowing sections, that seem to hold that under the special
provisions of the state tax law fair value for rate purposes
is the same as fair value for taxation.
§ 8. Tax and rate purpose — Nebraska Supreme Court in Bee
Building Co. Case, 1902.
The case of State ex rel. Bee Building Company v.
Savage,'® decided Sept. 18, 1902, involved the assessment
for tax purposes of the railroads of Nebraska. An action
of mandamus was brought for the purpose of compelling
the members of the State Board of Equalization to re-
assemble and reassess the property of the railroad, tele-
graph and sleeping-car companies doing business in Ne-
braska subject to taxation for general revenue purposes.
The Supreme Court of Nebraska held that under the
Nebraska law the railroads should be valued at the true
value of their tangible and intangible property, including
franchises, and taking into consideration the net earn-
ings and the market value of the stocks and bonds. In
other words, the fair market value of the property as a
going concern should govern. In discussing this question
the court states that the property can have but one true
value whatever the purpose of the investigation, whether
for the purpose of fixing fair value for rate making or for
«»65Neb. 714, 91N. W. 716.
Digitized by VjOOQ IC
§9] Purpose U
purposes of taxation. The court, by Judge Holcomb, says
(atpage724N. W.):
As to just what will detennine the value of the entire rail-
road property, a part of which is to be assessed in any one state
or taxing jurisdiction, the courts themselves are not in entire
accord. There are, doubtless, many elements and factors which
conduce to a correct determination of the true value, and may
properly be considered, which have received the approval of
the courts generally. It is not so important what the nature
of the inquiry is when the question of the true value of the prop-
erty is involved. The property can have but one true value,
whatever may be the purpose of the investigation. Whether
it be for the purpose of fixing reasonable rates for the trans-
portation of passengers and carrying of freight, or for the pur-
pose of taxation, the rule to be applied in ascertaining the value
of the property should be the same. If the railroad companies
insist that their property is of a certain value for the purpose
of determining what are reasonable maximum charges for the
transportation of passengers and carrying of freight, they have
no ground of complaint if the same property is assessed at the
same value for taxation purposes. The same property cannot
rightfully be valued at one sum for one of the purposes men-
tioned, and at a diflFerent amount for the other. The state
is too just in the administration of its laws to insist that rail-
road property should, for taxation, be considered as of very
great value, and for the purpose of regulating rates to be
charged by such corporations as common carriers that the
value of the same property is altogether lower.
As valuation for rate purposes was not submitted in
evidence or considered in any way in this case, the above
reasoning is pure dicta.
§ 9. Tax and rate purpose — District Judge McPherson in St.
Louis & S. F. R. Co. Rate Case, 1909.
St. Louis & S. F. R. Co. v. Hadley, Atty. Gen. of
Mo., 168 Fed. 317, decided March 8, 1909, is a railroad
Digitized by VjOOQ IC
12 Valuation [§ 9
rate case, in which an action was brought by eighteen
raihroad companies doing a general raiboad business
within Missouri, all but one doing both a state and an
interstate business, seeking to enjoin the attorney gen-
eral and Railroad Commissioners of Missouri from en-
forcing several statutes of Missouri fixing maximum
freight and passenger rates, on the ground that the rates
were not remimerative, but confiscatory. United States
District Judge Smith McPherson says (at page 323) :
Finding of fact No. 11: With the exceptions hereinafter
stated, the above valuations of the properties of said nine com-
panies as fixed are in fact practically the same as those fixed
by the state assessing board for the purpose of taxation. But
aside and apart from the valuations thus fixed by the state
board, these findings are that upon the whole evidence said
properties are at least of the values above fixed. The evidence
shows that included in such sums the state board, after making
certain valuations under the heading of "All Other Property"
fixed certain valuations, which when added give the totals as
above. In argument it was contended that *'A11 Other Prop-
erty" included franchise values. This is not deemed impor-
tant, because it is difficult to see wherein steam railroad prop-
erties, like those involved, can have a franchise value. But
waiving that, any franchise value that the state board could
have considered was necessarily so small a per cent, of the total
valuations fixed by the state board as to make no appreciable
difference in the result of these cases, because, if altogether
admitted, the remaining value is such that no road could obtain
a return to which it is herein found to be entitled. But if the
property has a franchise value for taxation, it also has such
valuation as an earning power, or, rather, upon which returns
should be made. In fixing the valuations above set forth, there
have been considered the immense terminal values of most of
the roads, the amount of stock and bonds outstanding, what
it would cost to duplicate the properties both with and without
terminals in the large cities, and all the evidence bearing on
Digitized by VjOOQ IC
§ 10] Purpose 13
present values, and in fixing said valuations the sums found
are the minimum valuations, the properties being worth at
least the sums thus fixed.
The foregoing valuations are the same as fixed by the state
assessing boards except as to the property of the St. Louis &
Hannibal and of the Kansas City, Clinton & Springfield in the
State, which are found to be worth 66§ per cent, of the val-
uations of the state boards. . . .
Judge MePherson continues at page 354:
In fixing the value the court has considered the evidence of
witnesses as to the stocks and bonds outstanding, and the
court has considered the evidence of the fact that the Mis-
souri state board for taxing purposes has valued these prop-
erties. Of course those findings are not binding nor con-
clusive, but they are persuasive. But independently of stocks
and bonds, and independently of what the state board has
valued these properties for taxing purposes, the evidence shows
the valuations to be as recited in the findings of fact herewith
filed, and to which reference will be made in the decrees.
§ 10. Tax and rate purpose — ^Arkansas Railroad Rate CaseSi
1911.
In re Arkansas Rate Cases," decided May 3, 1911, the
complainant railroads instituted proceedings in the
United States Circuit Court against the Board of Rail-
road Commissioners of Arkansas to enjoin the enforce-
ment of the freight and passenger tariffs promulgated
by that board, on the groimd that the rates, which appUed
solely to intrastate trafl&c, were noncompensatory and
confiscatory when appUed to the entire intrastate business
of each of the companies. In his decision in favor of the
complainants. District Judge Trieber says that by the
acts of the complainants the court was reUeved of the
" St. Louis Southw. Ry. Co. v, Allen et al,^ St. Louib, Iron Mountain
t So. Ry. Co. V, Same, 187 Fed. 290, 310, 319.
Digitized by VjOOQ IC
14 Valuation [§ U
very difficult problem of valuing the property, for the com-
plainants used as a basis of valuation the assessment
of their property for taxation by Arkansas made by the
State Board of Railroad Assessors, the reasonableness
of which was of course conceded by the defendants."
§ 11. Value for rate purpose and for public purchase.
It is doubtless true that there is a very close relation
between valuation for rate purpose and valuation for
pubUc purchase. Perhaps when the rules governing these
two kinds of valuation are finally worked out they will
be found to be not so very far apart. But in the mean-
time it is doubtless best to treat each as a distinct problem
and to apply with great caution precedents to one that
have been made with reference to the other. As the valu-
ation committee of the National Association of Railroad
Commissioners has pointed out there is one fundamental
distinction between fair value for rate purposes and fair
value for purchase, or condenmation: ^'
The thing of real importance in a rate case is not the fair value
of the property alone or the fair rate of return alone, but the
product of the two. This product is the net return that the
owners are to receive for the use of their property. If the total
net return is adequate, it is immaterial, in so far at least as the
justice of the result is concerned, whether, for example, there is
allowed a 7 per cent, return on a valuation of $1,000,000 or a
5 per cent, return on a valuation of $1,400,000, as the net return is
$70,000 in either case. In a case of condemnation or municipal
purchase, however, the valuation is final and all important. In
fixing conmiercial value, market value, or fair value under con-
"The valuation, as determined by the State Board of Railroad As-
sessors of Arkansas, is quoted ZT^fra, § 62.
^' Report of committee on raiboad taxes and plans for ascertaining the
fair value of railroad property, submitted to the Twenty-third Annual
Convention of the National Association of Railroad Commissioners,
October, 1911, p. 146.
Digitized by VjOOQ IC
§ 11] Purpose 15
demnation for the purchase of a plant operating under a per-
petual franchise the net return under legal or reasonable rates
is often the chief determining factor. The net return is capital-
ized at the rate considered fair for the purpose, and the result
is taken as the fair market or commercial value. Thus, recurring
to the above illustration, a net return of $70,000 capitalized on a
5 per cent, basis gives a valuation of $1,400,000. And if in this
case the present value of the physical plant has been found to be
$1,000,000, the difference, $400,000, is attributed to franchise
and going value. Owing to the fact that the rate of return
ordinarily deemed reasonable in a rate case is in excess of the
rate of capitalization that determines commercial value, the
commercial value will ordinarily exceed the fair value for rate
purposes.
The Wisconsin Railroad Commission in In re Manitowoc
Water Works Company, 7 W. R. C. R. 71, 72, decided
June 27, 1911, says:
The valuation placed upon utilities depends, to some extent
at least, upon the purposes for which it is intended. For instance,
in valuing utilities for the purpose of condemnation and pur-
chase, many elements must often be taken into account which
should not be given any consideration in valuations made for
the purposes of rate making.
That a fair value for rate purposes is not necessarily
the same as fair value for condemnation or purchase is
also recognized in the following cases:
Re gas and electric rates charged by the Queens Borough Gas
6 Electric Co., 2 P. S. C. 1st D. (N. Y.), decided June 23, 1911.
Mayhew v. Kings Co. Lighting Co., 2 P. S. C. 1st D. (N. Y.),
decided Oct. 20, 1911.
Willcox V. Consolidated Gas Co., 212 U. S. 19, 29 Sup. Ct. 192,
53 L. ed. 382, decided Jan. 4, 1909.
Omaha v. Omaha Water Co., 218 U. S. 180, 30 Sup. Ct. 616,
64 L. ed. 991, decided May 31, 1910.
Digitized by VjOOQ IC
16 Valuation [§ 12
Ames V, Union Pacific Ry. Co., 64 Fed. 165, decided Nov. 12,
1894.
Spring Valley Water Works v. San Francisco, 192 Fed. 137,
decided Oct. 21, 1911.
There are other cases that seem to hold that fair value for
rate purposes is substantially the same as fair value for
condenmation or purchase.^* In Spring Valley Water
Works V. City of San Francisco, 124 Fed. 574, 594-595,
decided Jime 29, 1903, Circuit Judge Morrow refers to a
number of cases including Monongahela Navigation
Co. V. United States,^* and says:
It is true that this was a condemnation proceeding, and the
question was to determine what was just compensation for the
appropriation of corporate property to a public use, while the
case before this court relates to the fixing of water rates which
shall be a just compensation for the appropriation of complain-
ant's property to a public use. It is not perceived that there is
any difference in the principles applicable to the two cases, and
this appears to have been the view of the Supreme Court in
San Diego Water Company v. San Diego, supra (118 Cal. 556).^®
§ 12. Capital value and rate and purchase value.
There may also be a close relation between correct
principles of valuation for accoimting and capitalization
purposes and valuation for rate purposes and for public
purchase. This will be true if valuation for the latter
purposes is based on actual cost. If, however, valuation
for rate purposes and pubUc purchase is based chiefly
on reproduction cost the similarity in principles will be
comparatively small. Correct accounting principles aim
to show the actual cost of the enterprise. Conserva-
" See E. C. Bailly, The Legal Basis of Rate Regulation, in Columbia
Law Review, June, 1911, p. 334. See also Reagan v. Farmers' Loan A
Trust Company, quoted in § 60.
» 148 U. S. 312, 13 Sup. Ct. 622, 37 L. ed. 463, March 27, 1893.
" 50 Pac. 633, 38 L. R. A. 460, decided October 9, 1897.
Digitized by VjOOQ IC
§ 12] Purpose 17
tive principles of capitalization would keep capitali-
zation close to the actual cost. The valuation committee
of the National Association of Railway Commissioners
expresses this situation as follows: ^^
The books of a company kept from the start in accordance
with a correct accounting system would show a capital account
that would be closer to what seems a just fair value for rate
purposes than any other single basis. But owing^ perhaps, to
lack of accounts kept as above, the court decisions have given
greater weight to cost of reproduction or cost of reproduction
less depreciation than to actual cost in determining fair value
for rate purposes. Capitalization, or the amount of stock and
bonds issued (which may be a very diJBferent amount from the
book assets), might also if issued under strict supervision from
the start be a most important element in fixing fair value for
rate purposes. If the bonds, however, were issued either at a
premium or at a discount this fact would have to be taken into
account. Whether bonds are issued at a premium or a discount,
it is the actual amount in money received therefrom that is of
importance in fixing value for rate purposes. The same may be
said of stock issued at a premium.
However, the f imdamental distinction for present purposes
between accoimting and capitaUzation and valuation for
rate purposes and for public purchase is that the rules as to
accounting and capitalization are subject entirely to the
control of the various commissions and legislatures. They
involve no constitutional rights. The basis of valuation
for rate purposes and public purchase on the other hand
will necessarily be fixed by the Supreme Court of the
United States.
^ Report of oommittee on raiht>ad taxes and plans for ascertaining the
fair value of railroad property submitted to the twenty-third annual con-
vention of the National Association of Railway Conunissionersy October,
1911, p. 148
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CHAPTER II
Fair Value for Rate Purposes
§ 20. Earlier decisions.
21. Justice Brewer in Union Pacific Railway Cases, 1894 — No hard and
fast rule of valuation.
22. Circuit Judge Ross in San Diego Land and Town Case, 1896 —
Present value, not cost, the true basis.
23. Circuit Judge Thayer in Kansas City Stock-Yards Case, 1897— Cost
plus appreciation in value.
24. Justice Harlan in Smyth v. Ames, 1898 — Fair value of property used
and how ascertained.
25. Justice Harlan in San Diego Land and Town Case, 1899 — ^Reason-
able value at time used.
26. Justice Holmes in San Diego Land and Town Case, 1903 — ^Reason-
able value at time used.
27. Circuit Judge Morrow in Spring Valley Water Case, 1903 — Reason-
able value at time used.
28. Justice Peckham in San Joaquin Irrigation Case, 1904 — Present value.
29. Columbus, Ohio, Electricity Rate Case, 1906 — Fair present value of
tangible and intangible property.
30. Justice Peckham in Consolidated Gas Case, 1909 — Fair value gen-
erally includes appreciation.
31. Iowa Supreme Coiul in Cedar Rapids Gas Case, 1909 — ^Reproduo-
tion-cost-less-depreciation the controlling factor.
32. Oklahoma Supreme Court in Pioneer Telephone Case, 1911 — Re-
production-cost-less-depreciation the controlling factor.
33. District Judge Evans in Cumberland Telephone Company Case,
1911 — Fair value not determined by construction cost.
34. Wisconsin Railroad Commission in Manitowoc Water Case, 1911 —
Elements of physical valuation.
35. District Judge Farrington in Spring Valley Water Rate Case, 1911 —
Elements of fair value reviewed.
36. Trend of decisions on fair value.
37. No authoritative determination of standard of value.
38. Recent decisions.
39. Valuation standards.
§20. Earlier decisions.
The discussion of fair value for rate purposes is of recent
origin. As we have seen above (§3), the courts have
1 18 J
Digitized by VjOOQ iC
§ 21] Fair Value 19
but recently held that a rate established under the author-
ity of a state could be annulled on the ground that it
failed to afiford the company a fair return on the fair value
of its property. Consequently the elements of fair value
have only recently been discussed. In the earlier of these
opinions the discussions are vague and do not attempt
to actually fix a fair value for the purposes of the case in
hand. Detailed information for this purpose was for the
most part lacking, and the discussion of the court was
largely in the nature of dicta. It is only in a few of the
most recent cases that the court has had the complete
data essential to more definite conclusions. In the fol-
lowing pages the court decisions are quoted with a view
to showing in the courts' own words the development
of this concept.
§ 21. Justice Brewer in Union Pacific Railway Cases, 1894
—No hard and fast rule of valuation.
In Ames v. Union Pacific Railway Company, 64 Fed.
165, decided in the United States Circuit Court on Novem-
ber 12, 1894,^ actions were brought by the complainants,
stockholders in the railroad corporations named as de-
fendants, to restrain by injimction the officials of the State
of Nebraska from enforcing certain acts of the Nebraska
legislature prescribing maximum rates on intrastate rail-
road freight. The injunction was granted. Justice Brewer
says (at page 177) :
What is the test by which the reasonableness of rates is de-
termined? This is not yet fully settled. Indeed, it is doubtful
whether any single rule can be laid down, applicable to all
cases. If it be said that the rates must be such as to secure to
the owners a reasonable per cent, on the money invested, it
' The decision covered also the cases of Smith et al, v. Chicago & N. W.
R. Co. et al,, Higgonson et al, v, Chicago, B. & Q. R. Co. et al.
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20 Valuation [§ 21
will be remembered that many things have happened to make
the investment far in excess of the actual value of the property, —
injudicious contracts, poor engineering, unusually high cost of
material, rascality on the part of those engaged in the construc-
tion or management of the property. These and many other
things, as is well known, are factors which have largely entered
into the investments with which many railroad properties stand
charged. Now, if the public was seeking to take title to the
railroad by condemnation, the present value of the property, and
not the cost, is that which would have to pay. In like manner,
it may be argued that, when the legislature assumes the right to
reduce, the rates so reduced cannot be adjudged unreasonable if,
under them, there is earned by the railroad company a fair
interest on the actual value of the property. It is not easy to
always determine the value of railroad property, and if there is
no other testimony in respect thereto than the amount of stock
and bonds outstanding, or the construction account, it may be
fairly assumed that one or other of these represents it, and com-
putation as to the compensatory quality of rates may be based
upon such amounts. In the cases before us, however, there is
abundant testimony that the cost of reproducing these roads is
less than the amount of the stock and bond account, or the
cost of construction, and that the present value of the property
is not accurately represented by either the stocks and bonds, or
the original construction account. Nevertheless, the amount of
money that has gone into the railroad property — the actual
investment, as expressed, theoretically, at least, by the amount
of stocks and bonds — ^is not to be ignored, even though such sum
is far in excess of the present value. It was said in the case of
Reagan v. Farmers' Loan & Trust Co., 154 U. S. 362, 41-2, 38 L.
ed. 1014, 14 Sup. Ct. 1047, 1059, decided May 26, 1894:
It is unnecessary to decide, and we do not wish to be understood
as laying down an absolute rule, that in every case a failure to pro-
duce some profit to those who have invested their money in the build-
ing of a road is conclusive that the tariff is unjust and unreasonable.
And yet justice demands that every one should receive some com-
pensation for the use of his money or property, if it be possible, with-
out prejudice to the rights of others.
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§21] Fair Value 21
It is not always reasonable to cast the entire burden of the de-
preciation on those who have invested their money in railroads.
Take the Union Pacific Railway, for illustration. At the time the
government created the corporation, to induce the building of
this transcontinental road through a largely unoccupied terri-
tory, it loaned to the company $16,000 a mile; taking as security
therefor a second lien on the property, and granting to the corpo-
ration the right to create a prior lien to an equal amount, which
was done. There is testimony tending to show that the road in
Nebraska could be built to-day for $20,000 a mile. Would it
be full justice to the government, would it satisfy the common
sense of right and wrong, would it be reasonable, for the state
of Nebraska to so reduce the rates that the earnings of the road
would only pay ordinary interest on $20,000 a mile, and so, the
holders of the first lien being paid their interest, the government
be forced to be content with only interest on one-fourth of its
investment? Or, to put the case in a little stronger light, sup-
pose the promoter of this enterprise had been some private
citizen, who had advanced his $16,000 a mile as a second lien,
and thai the road could be constructed to-day for only $16,000
a mile. Would it be reasonable and just to so reduce rates as
to simply pay to the holders of the first lien reasonable interest,
and leave him without any recompense for his investment?
Is there not an element of equity which puts the reduction of
rates in a different attitude from the absolute taking of the prop-
erty by virtue of eminent domain? In the latter case, while
only the value is paid, yet that value is actually paid, and the
owners may reinvest, and take the chances of gain elsewhere,
whereas, if the property is not taken, the owners have no other
recourse than to receive the sum which the property they must
continue to own will earn under the reduced rates. Considera-
tions such as these compel me to say that I think there is
no hard and fast test which can be laid down to determine in all
cases whether the rates prescribed by the legislature are just and
reasonable, and that often many factors enter into the determi-
nation of the problem.
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22 Valuation [§ 22
§22. Circuit Judge Ross in San Diego Land and Town
Case, 1896— Present value, not cost, the true basis.
In San Diego Land and Town Company v. National
City, 74 Fed. 79, United States Circuit Court, decided
May 4, 1896, an action was brought to enjoin the en-
forcement of an ordinance of the board of trustees of a
municipality establishing water rates. The complaint
was dismissed. Judge Ross says (at pages 83, 84) :
In the solution of that problem many considerations may
enter; among them, the amount of money actually invested.
But that is by no means, of itself, controlling, even where the
property was at the time fairly worth what it cost. If it has
since enhanced in value, those who invested their money in it,
like others who invest their money in any other kind of property,
are justly entitled to the benefit of the increased value. If, on
the other hand, the property has decreased in value, it is but
right that those who invested their money in it, and took the
chances of an increase in value, should bear the burden of the
decrease. In my judgment, it is the actual value of the property
at the time the rates are to be fixed that should form the basis
upon which to compute just rates; having, at the same time, due
regard to the rights of the public, and to the cost of maintenance
of the plant, and its depreciation by reason of wear and tear.
If one has property to sell, it is its present value that is looked to,
one element of which may very properly be its cost; but one ele-
ment only. So, too, if one has property to tease, it is its present
value, rather th^n its cost, upon which the amount of rent is
based. And if, as said by Mr. Justice Brewer in Ames v. Rail-
way Co. [64 Fed. 165, quoted in § 21,] supra, the public
were seeking to condemn the property in question for a greater
public use, if that be possible, its present value, and not its cost,
is that which the public would have to pay. It follows, I think,
that, where the public undertakes to reduce the rates to be
charged for the use of such property, it is its present value, and
not its cost, that must be taken as a basis upon which to fix
reasonable and just rates; having due regard to the cost of its
maintenance, to its depreciation by reason of wear and tear, and
Digitized by VjOOQ iC
§ 23] Pair Value 23
also to the rights of the public. If, upon such a basis, a fair
interest is allowed, no just cause of complaint can exist.'
In San Diego Land and Town Co. v. Jasper, 110 Fed.
702, 714, decided August 26, 1901,» Judge Ross reaflBnns
the views expressed by him in 74 Fed. 79.
§ 23. Circuit Judge Thayer in Kansas City Stock- Yards Case,
1897— Cost plus appreciation in value.
In Cotting v. Kansas City Stock- Yards Co., 82 Fed.
850, 854, decided October 28, 1897, actions were brought
to enjoin the enforcement of statutes of the State of
Kansas fixing maximum charges for services at complain-
ant's live-stock yards. Upon the final hearing the Federal
Circuit Court dismissed the complaint, though granting
a temporary injimction pending an appeal. Circuit
Judge Thayer said (at pages 854, 855) :
When a valuation is placed on property which has become af-
fected with a public use, for the purpose of ascertaining whether
the maximum rate of compensation fixed by law for its use is
reasonable or otherwise, it is obvious that the income derived
therefrom by the owner before it was subjected to legislative
control cannot always be accepted as a proper test of value,
because the compensation which the owner charged for its
use may have been excessive and unreasonable. Again, when
property has been capitalized by issuing stock, neither the
market value nor the par value of the stock can be accepted in
all cases as a proper criterion of value, because the stock may
not represent the money actually invested, and, furthermore,
because the property may have been capitalized mainly with
reference to its income-producing capacity, on the assumption
that it is ordinary private property, which the owner may use as
he thinks proper, without being subject to legislative control.
* For the opinion of Justice Harlan on appeal of this case to the United
States Supreme Court, see § 25.
* For opinion of United States Supreme Court on appeal of this case,
see infra, $ 26.
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24 Valuation [§ 24
On the other hand, however, when property is valued for the
purpose last stated, it is clear that the owner thereof is entitled
to the benefit of any appreciation in value above the original cost
and the cost of improvements, which is due to what may be
termed natural causes. If improvements made in the vicinity of
the property, the growth of the city or town where it is located,
the building of railroads, the development of the surrounding
country, and other like causes, give property an increased value,
the owner cannot be deprived of such increase by legislative
action which prevents him from realizing an income commen-
surate with the enhanced value of his property. . . . Upon the
whole, therefore, the court concludes that the value of the prop-
erty used for stock-yards purposes, as assessed by the master,
is not unreasonable, considering the object for which such val-
uation was made, and that no sufficient reasons have been
shown for disturbing the finding of the master on that issue.^
§ 24. Justice Harlan in Smyth v. Ames, 1898— Fair value of
property used and how ascertained.
Smyth V. Ames, 169 U. S. 466, 18 Sup. Ct. 418, 42 L.
ed. 819, decided March 7, 1898, is a leading case on the
question of the determination of reasonable rates. In
this case the United States Supreme Court decided against
the constitutionality of a Nebraska statute establishing
maximum freight rates. Justice Harlan, in delivering
the opinion of the court, says (at page 544) :
If a railroad corporation . has bonded its property for an
amount that exceeds its fair value, or if its capitalization is
largely fictitious, it may not impose upon the public the bur-
den of such increased rates as may be required for the purpose
* Upon appeal to the United States Supreme Court, the decree of the
Circuit Court was reversed with directions that the complainant's prayer
be granted, upon the ground that the statute in question violated the
Fourteenth Amendment to the United States Constitution in that it ap-
plied only to the Kansas City Stock-Yards Company and not to other
companies or persons engaged in like business in Kansas.
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§ 24] Faib Value 25
of realizing profits upon such excessive valuation or fictitious
capitalization; and the apparent value of the property and.
franchises used by the corporation, as represented by its stocks,
bonds, and obligations, is not alone to be considered when de-
termining the rates that may be reasonably charged. . . .
The court here quotes Covington and Lexington Turn-
pike Road V. Sandford, 164 U. S. 578, 17 Sup. Ct. 198, 41
L. ed. 560, decided December 14, 1896, and continues (at
pages 545, 546) :
A corporation maintaining a public highway, although it owns
the property it employs for accomplishing public objects, must
be held to have accepted its rights, privileges, and franchises
subject to the condition that the government creating it, or the
government within whose limits it conducts its business, may by
legislation protect the people against unreasonable charges, for
the services rendered by it. It cannot be assumed that any
railroad corporation, accepting franchises, rights and privi-
l^es at the hands of the public, ever supposed that it acquired,
or that it was intended to grant to it, the power to construct
and maintain a public highway simply for its benefit, without
regard to the rights of the public. But it is equally true that
the corporation performing such public services and the people
interested in its business and affairs have rights that may not be
invaded by legislative enactment in disisegard of the fundamen-
tal guarantees for the protection of property. The corporation
may not be required to use its property for the benefit of the pub-
lic without receiving just compensation for the services ren-
dered by it. How such compensation may be ascertained, and
what are the necessary elements in such mquiry, will always
be an embarrassing question. . . .
We hold, however, that the basis of all calculations as to the
the reasonableness of rates to be charged by a corporation main-
taining a highway under l^slative sanction must be the fair
value of the property being used by it for the convenience of
the public. And in order to ascertain that value, the original
cost of construction, the amount expended m permanent im-
i
Digitized by VjOOQ IC
26 Valuation [$ 25
provements, the amount and market value of its bonds and
stock, the present as compared with the original cost of con-
struction, the probable earning capacity of the property under
particular rates prescribed by statute, and the sum required
to meet operating expenses, are all matters for consideration,
and are to be given such weight as may be just and right in each
case. We do not say that there may not be other matters to
be regarded in estimating the value of the property. What the
company is entitled to ask is a fair return upon the value of that
which it employs for the public convenience. On the other
hand, what the public is entitled to demand is that no more be
exacted from it for the use of a public highway than the serv-
ices rendered by it are reasonably worth.
In the foregoing case the court did not attempt to fix
the fair value of the property, so that the above is very
largely dicta. After considering the efifect of the proposed
rates on the earnings of the companies, the court came to
the conclusion that they could not be considered reason-
able on any possible basis of value.
§ 26. Justice Harlan in San Diego Land and Town Case, 1899
—Reasonable value at time used.
In San Diego Land and Town Company v. National
City, 174 U. S. 739, 19 Sup. Ct. 804, 43 L. ed. 1154, decided
May 22, 1899, in which the United States Supreme Court
affirmed a dismissal by the Circuit Court of a complaint in
an action to enjoin the enforcement of a municipal ordi-
nance establishing water rates (see § 22, supra), Jus-
tice Harlan, writing the opinion of the court, says (at
pages 757-758) :
The contention of the appellant in the present case is that
in ascertaining what are just rates the court should take into
consideration the cost of its plant; the cost per anniun of oper-
ating the plant, including interest paid on money borrowed and
reasonably necessary to be used in constructing the same; the
Digitized by VjOOQ IC
§ 26] Fair Value 27
annual depreciation of the plant from natural causes resulting
from its use; and a fair profit to the company over and above
such charges for its services in supplying the water to consumers,
either by way of interest on the money it has expended for the
public use, or upon some other fair and equitable basis. Un-
doubtedly, all these matters ought to be taken into considera-
tion, and such weight be given them, when rates are being fixed,
as under all the circumstances will be just to the company and
to the public. The basis of calculation suggested by the ap-
pellant is, however, defective in not requiring the real value of
the property and the fair value in themselves of the services
rendered to be taken into consideration. What the company
is entitled to demand, in order that it may have just compen-
sation, is a fair return upon the reasonable value of the property
at the time it is being used for the public. The property may
have cost more than it ought to have cost, and its outstanding
bonds for money borrowed and which went into the plant may
be in excess of the real value of the property. So that it cannot
be said that the amount of such bonds should in every case
control the question of rates, although it may be an element
in the inquiry as to what is, all the circumstances considered,
just both to the company and to the public.
§ 26. Justice Holmes in San Diego Land and Town Casei
1903— Reasonable value at time used.
In San Diego Land and Town Company v. Jasper,
189 U. S. 439, 23 Sup. Ct. 571, 47 L. ed. 892, decided
April 6, 1903, an action in equity was brought in the
Federal Circuit Court against the board of supervisors
of San Diego County and others for the purpose of hav-
ing certain water rates which had been fixed by the board
declared void on the groimd of being unduly low. The
Circuit Court dismissed the complaint (San Diego Land
and Town Co. v. Jasper, 110 Fed. 702, see also § 22, supra)
and on appeal to the United States Supreme Court the dis-
missal was aflSrmed. Justice Holmes, writing the opinion
of the court, says (at pages 442, 443) :
Digitized by VjOOQ IC
28 Valuation [§ 27
The main object of attack is the valuation of the plant. It
no longer is open to dispute that under the constitution "what
the company is entitled to demand, in order that it may have
just compensation, is a fair return upon the reasonable value
of the property at the time it is being used for the public." San
Diego Land and Town Company v. National City, 174 U. S. 739
and 757.^ That is decided, and is decided as against the con-
tention that you are to take the actual cost of the plant, annual
depreciatioil, etc., and to allow a fair profit on that footing over
the above expenses. We see no reason to doubt that the Cal-
ifornia statute means the same thing. Yet the only evidence
in favor of the higher value in the present case, is the original
cost of the work, seemingly inflated by improper charges to
that account and by injudicious expenditures (being the cost
to another company which sold out on foreclosure to the ap-
pellant), coupled with a recurrence to testimony as to the
rapid depreciation of the pipes. In this way the appellant
makes the value over a million dollars. No doubt cost may be
considered, and will have more or less importance according to
circumstances. In the present case it is evident for reasons,
some of which will appear in a moment that it has very little
importance indeed.
§ 27. Circuit Judge Morrow in Spring Valley Water Case,
1903— Reasonable value at time used.
In Spring Valley Waterworks v. San Francisco, 124
Fed. 574, decided June 29, 1903, upon a motion for a
preliminary injunction to restrain the city and county
of San Francisco and its board of supervisors and con-
sumers from enforcing an ordinance of the board which
prescribed certain water rates, Circuit Judge Morrow,
in granting the motion, says (at pp. 591, 595) with refer-
ence to the valuation of complainant's water plant:
It may be considered as established that it is the reasonable
value of the property at the time it is being used for the public
service, but how this value is to be ascertained, and what el^
B Quoted above, § 25.
Digitized by VjOOQ IC
§ 28] Fair Value 29
ments are to be included in the estimate, are still subjects of
controversy. . . .
The principles of just compensation established by the courts
in the several cases they have had under consideration are of
great assistance in solving many of the difficult questions in-
volved in this character of litigation; but the application of
these principles to the facts of a particular case is, after all, the
simple rule of determining what, under all the circmnstances,
is reasonable and just as between the rate payers and the cor-
poration engaged in performing the public service.
§ 28. Justice Peckham in San Joaquin Irrigation Case, 1904—
Present value.
In Stanislaus County v. San Joaquin and King's River
Canal and Irrigation Co., 192 U. S. 201, 26 Sup. Ct.
241, 48 L. ed. 406, decided January 18, 1904, Stanis-
laus County, California, appealed to the United States
Supreme Court from a decree of the Circuit Court set-
ting aside an ordinance adopted by the board of super-
visors of the coimty prescribing the water rates to be
charged by the water company for the ensuing year.
In reversing the decree of the court below. Justice Peck-
ham, delivering the Supreme Court's opinion, says (at
pages 213,214):
It is not confiscation nor a taking of property without due
process of law, nor a denial of the equal protection of the laws, to
fix water rates so as to give an income of 6 per cent, upon the
then value of the property actually used, for the purpose of
supplying water as provided by law, even though the company
had prior thereto been allowed to fix rates that would secure to
it one and a half per cent, a month income upon the capital ac-
tually invested in the undertaking. . . . The original cost may
have been too great; mistakes of construction, even though
honest, may have been made, which necessarily enhanced the
cost; more property may have been acquired than necessary
or needful for the purpose intended.
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^30 Valuation [§ 29
§29. Columbus, Ohio, Electricity Rate Case, 1906— Fair
present value of tangible and intangible property.
In the case of Columbus Railway and Light Company
V. City of Columbus, an application was made for an
injunction against the enforcement of a city ordinance
reducing electricity rates. The special master reported
in favor of a permanent injunction and his report was con-
firmed by the United States Circuit Court without
opinion. The special master, after quoting at length
from the decisions of the coiuts in relation to fair value,
says (at pages 29, 49) : ®
In other words, fictitious values will be disregarded, improvi-
dent and imwise expenditures will not be taken into account, but
only the fair value of the property will be used as a basis, in-
cluding, however, in such fair value not only the tangible prop-
erty devoted to the public service, but such intangible value as
may be legitimate and may be justly, under all circumstances,
credited to the producer on the one hand, and debited to the
consumer on the other, so as to bring about the just compensa-
tion rightly belonging to the company, and legitimately to be
paid for by the consumer.
Necessarily the ascertainment of such value is in all cases a
difficult matter, and its final adjustment by the court can rarely,
if at all, be made with mathematical exactness. All the court can
do is, from the evidence, to arrive at such a value as will, all
things considered, be fairly equally just to both parties. . . .
Considering all of the above elements as entering into the
valuation of complainant's property, viz., the total cost thereof
$2,000,000, the rental or purchase price $1,650,000; the fair
replacement value of its tangible property at about $1,600,000;
the depreciation properly to be allowed for property not neces-
sary for present use in supplying the service demanded; the
addition after the purchase from complainant's lessor of over
• Columbus Railway and Light Ck). v. City of Columbus, No. 1206, in
equity, United States Circuit Court, Southern District of Ohio, Eastern
Division, Report of Special Master T. P. Linn, June 8, 1906.
Digitized by VjOOQ IC
§ 30] Fair Value 31
$350,000 in cash by way of improvements and extensions; the
market value of its securities at the time and shortly prior to the
lease $1,700,000, and without attempting to fix any definite
value upon the intangible assets, I conclude that the fair value
of complainant's property devoted to the public service upon
which it is entitled to ask a fair return, and for which the public
should be required to pay a reasonable price for its use, is, at
least, the sum of $1,650,000. Manifestly this valuation cannot
be made with mathematical accuracy, but in view of the testi-
mony, which can not be reviewed here in detail, it is a valuation
which seems to me just to both complainant and defendant as a
basis for determining whether or not the ordinance in question
will result, upon this valuation, in taking complainant's prop-
erty without due process of law.
§ 30. Justice Peckham in Consolidated Gas Case, 1909— Fair
value generally includes appreciation.
In Willcox V. Consolidated Gas Co., 212 U. S. 19, 29
Sup. Ct. 192, 53 L. ed. 382, decided January 4, 1909, where
it was sought to restrain the enforcement of gas rates
prescribed by the New York state legislature, and the Gas
Commission, Justice Peckham says (at page 52) :
And we concur with the court below in holding that the
value of the property is to be determined as of the time when
the inquiry is made regarding the rates. If the property, which
l^ally enters into the consideration of the question of rates, has
increased in value since it was acquired, the company is entitled
to the benefit of such increase. This is, at any rate, the general
rule. We do not say there may not possibly be an exception to
it, where the property may have increased so enormously in
value as to render a rate permitting a reasonable return upon
such increased value unjust to the public. How such facts
should be treated is not a question now before us, as this case
does not present it. We refer to the matter only for the purpose
of stating that the decision herein does not prevent an inquiry
into the question when, if ever, it should be necessarily pre-
sented.
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32 Valuation [§31
§ 31. Iowa Supreme Court in Cedar Rapids Gas Case, 1909—
Reproduction-cost-less-depreciation the controlling factor.
In Cedar Rapids Gas Light Company v. Cedar Rapids,
144 Iowa, 426, 120 N. W. 966, 968, decided May 4, 1909,
upon an appeal from a dismissal of a complaint to enjoin
the enforcement of an ordinance of the council of the city
of Cedar Rapids fixing the price of gas, the Iowa Supreme
Court, in affirming the dismissal said, at page 432, per
Judge Ladd:
There is no controversy, however, if we understand counsel
rightly, but that the company is entitled to have its property
appraised at its fair value in December, 1906. What such an
enterprise was then worth cannot be determined by the mere
addition of the separate values of its component parts, nor from
the cost alone, nor from what it formerly might have been sold
at if such price were influenced by excessive rates, nor from
what it might cost to replace alone, for this, in view of its use,
would involve mere estimates of depreciation and contingencies
incident to construction. . . .
Any person or corporation contemplating the purchase of
such a property quite naturally would inquire into its history,
the character of its management in the past, and the amoimt
expended in its construction. ... A careful review of the en-
tire record, which has been repeated, has led to the conclusion
that a fair valuation of the entire plant is somewhere between
$300,000 and $350,000. This is largely in excess of its cost, but,
according to the record, the value of material as well as the cost
of labor has greatly increased since much of the plant was con-
structed. On the other hand, to put the value above the limit
mentioned would require us to ignore the depreciation due to
age, decay, inadequacy, and the Uke, on account of which de-
fendant has been charging off its books large sums, and which
the proof shows should be taken into account.
This decision was affirmed by the Supreme Court of
the United States, March 11, 1912 (223 U. S. 670). Jus-
Digitized by VjOOQ IC
§ 321 Fair Value 33
tice Holmes states that the attitude of the state court
was " fair " and that it had " fixed a value on the plant
that considerably exceeded its cost."
§ 88. Oklahoma Supreme Court in Pioneer Telephone Case,
1911— Reproduction-cost-less-depreciation the control-
ling factor.
In Pioneer Telephone and Telegraph Company v.
Westenhaver, 29 Okl. — , 118 Pac. 354, decided Janu-
ary 10, 1911, an appeal was taken by the telephone
company to the Supreme Court of Oklahoma from an
order of the Corporation Commission directing the resto-
ration substantially of certain telephone rates which had
been increased by the company. In the course of the pro-
ceeding before the Corporation Commission a valuation
was made of the company's plant. In reversing the Com-
missioners' order, the court, per Judge Hayes, says (at
pages 365, 356):
The basis of all calculations as to the reasonableness of the
rates to be charged by public service corporations is the fair
value of the property used by the corporation in rendering the
service to the public. . . . The rate is fair when its application
will yield a fair return upon the reasonable value of the property
at the time it is being used for the public. It is unfair, when it
does not yield such return. ... No inflexible method for the
ascertainment of the value of the property used in the service
has been fixed by legislative bodies dealing with rates, or by the
courts in detennining the validity of rates, and from the nature
of the subject no inflexible method can be fixed. Sometimes
the present value is arrived at by ascertaining the original cost
(rf coDstructioa and all betterments, and deducting therefrom
for depreciation; but this method does not always prove to be
fair and just. If there was extravagance and unnecessary waste
in the construction, or, as is often the case, fictitious stocks and
bonds issued, the proceeds of which did not go into the original
eoBsiructimi, such method would prove unfair to the public.
3
Digitized by VjOOQ IC
34 Valuation [§ 33
On the other hand, where the market price of the physical units
or of the labor entering into the construction of the plant has
advanced since its construction, the original cost may be much
lower than the present value; and for that reason be to the owner
of the plant an unfair determination of its pres^at value. The
method most frequently used is to ascertain what it will cost to
reproduce the plant or the cost of its replacement at the present
time, and deduct therefrom for depreciation in the existing plant.
Both methods may be used and considered in ascertaining the
present value, and both are often resorted to as was done in
this case.
§ 33. District Judge Evans in Cumberland Telephone Com-
pany Case, 1911— Fair value not determined by con-
struction cost
Cumberland Telephone and Telegraph Company v.
City of Louisville, 187 Fed. 637, decided April 25, 1911,
United States Circuit Court, was a suit to enjoin the en-
forcement of a rate ordinance. District Judge Evans
in granting the injunction asked for, says (at page 642) :
The ascertainment of the present value of the company's
plant is therefore a matter of prime importance, and the subject,
speaking generally, may be viewed from many standpoints, as
to which it may suffice for present purposes to suggest that if
the expenditures in the construction and equipment of a public
utility corporation have been absurdly extravagant and waste-
ful it would not be admissible to say that such outlays fairly
indicated the real value of its plant nor in such a state of case
that rates should be fixed upon a scale that wotdd pay ordinary
dividends upon a licentiously extravagant cost of property, and
similar considerations might apply if fictitious values were the
result of ''watering" the stock. On the other hand, if property
had been obtained at a price far below its real value in better
hands, or if some one of the many accidents or unsuspected
reasons for a large increase should fortunately operate to double
the value of a plant it would not be just nor reasonable to con-
fine ourselves to the lower or former value not to say that such
Digitized by VjOOQ IC
§ 34J Fair Value 35
former value continued to be the real one. The vfilue of a plant
may depend upon good fortune, upon good management or
upon fortuitous circumstances, but in every event the reason-
able value of the property "at the time it is used for the public"
is the value we are to ascertain for the purposes of this contro-
versy.
§ 34. Wisconsin Railroad Commission in Manitowoc Water
Case, 1911— Elements of physical valuation.
In re Manitowoc Water Works Company, 7 W. R, C. R.
71, 74, decided June 27, 1911, the Wisconsin Railroad
ConajBission says:
In determining the value of the physical property of a public
utility several elements must be taken into consideration. The
three elements of greatest importance in fixing the value of such
plants are the original cost, the cost of reproducing the plant,
and the present value. As to which of these elements shall be
given the greatest consideration, must depend upon the circum-
stances in each case and must also depend upon the purpose for
which the valuation is made. See Hill et al. v. Antigo Water
Co., 3 W. R. C. R. 623, 631; In re Menommee and Marmette
Light and Traction Co., 3 W. R. C. R. 778, 785-787; State
Journal Prtg. Co. et al. v. Madison Gas & Electric Co., 4 W.
R. C. R. 501, 557.
§ 36. District Judge Farrington in Spring Valley Water Rate
Case, 1911— Elements of fair value reviewed.
In the case of Spring Valley Water Works v. San Fran-
cisco, 192 Fed. 137, decided October 21, 1911, District
Judge Farrington gives a comprehensive and carefully
considered opinion in regard to the elements of fair value.
This case is a continuation of the case by the same title
reported in 165 Fed. 667 and decided October 7, 1908,
and in which the opinion was also by Judge Farrington.
In the 1911 case a permanent injuuction was granted
against the enforcement of rates, fixed by municipal ordi-
Digitized by VjOOQ IC
36 Valuation [§ 35
nance. In that case District Judge Farrington said (at
pages 145, 146) : ^
8. What the company is entitled to demand in order that
it may have just compensation, is a fair return upon the reason-
able value of the property at the time it is bemg used for the
public. . . .
9. The public has a right to demand that no more shall be
exacted than the services rendered are reasonably worth. The
public cannot be subjected to unreasonable rates in order simply
that stockholders may earn dividends. . . .
10. Cost of reproduction is not a fair measure of value,
unless a proper allowance is made for depreciation, because all
constructive portions of the plant are subject to decay, and to
be worn out or consumed by use. . . .
11. Original cost is not always a fair criterion of present
value, because the plant may have cost too much, or it may be of
unnecessary dimensions. If it has increased in value since its
acquisition, the company is entitled to the benefit of such in-
crease, if such increased valuation does not require a return so
large as to be unreasonable and unjust to the public. . . .
12. The aggregate value of bonds and issued capital stock of
the company at present market prices is not a reliable index
of the value of the plant, because such prices often rise and fall
from the operation of causes which have little or nothing to do
with the real intrinsic value of the property, and the bonded
or other indebtedness of the company may exceed the actual
value of its property.
The most important fact to be determined is the value of the
property. The value to be ascertained is the value at the time
of the inquiry. Only that property is to be considered which
was then used and useful in supplying San Francisco with water.
Among the proper matters to be considered are the original
cost of construction; the amount expended in permanent im-
provements; the amoimt and market value of stock and bonds;
the preseht, as compared with original, cost of construction; the
probable earning capacity of the property under the particular
rates prescribed by the ordinance for each of the years in ques-
Digitized by VjOOQ IC
§ 36] Pair Valub 37
lion; the sums required to meet operating expenses; what it
will cost to obtain water, equal in quantity and quality to the
present supply, from the next most available source; the de-
preciation suffered by that portion of the plant which is worn by
use or action of the elements, or shorn of its value by newer,
cheaper, and more efficient appliances and machinery; the fact
that the plant has a franchise and is a going concern, with an
established business and thousands of customers, whose buildings
are connected with the distributing system; and appreciation
in value since the various properties constituting the plant were
acquired. To each of these factors just and proper weight must
be given; and, finally, the result must be the reasonable and fair
value of the plant as between the company and the public.
§ 36. Trend of decisions on fair value.
In 1898, in the leading case of Smyth v. Ames, decided
March 7, 1898 (see above, §24), Justice Harlan said:
"We hold, however, that the basis of all calculations
as to the reasonableness of rates . . . must be the fair
value of the property being used ... for the convenience
of the public." This principle was repeated the following
year by Justice Harlan in San Diego Land and Town Co.
V. National City (see above, § 25) and In 1903 by Justice
Hohnes in San Di^o Land and Town Co. v. Jasper (see
above, § 26).
In Smyth v. Ames, also. Justice Harlan pointed out
certain elements to be considered in determining the fair
value of property being used (see above, § 24). He says
that "the original cost of construction, the amount
expended in permanent improvements, the amoimt and
market value of its bonds and stock, the present as com-
pared with the original cost of construction; the probable
earning capacity under particular rates prescribed by
statute, and the sum required to meet operating expenses,
are all matters for consideration and are to be given such
weight as is just and right in each case." The court, how-
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38 Valuation [§ 37
ever, is careful to add that there may be other elements
besides those enimierated that should be taken into con-
sideration in fixing fair value. The court evidently felt
that the equities of each case should detennine the weight
to be given to these various elements. It evidently agrees
with the statement made by Justice Brewer in the Circuit
Court in 1894 that "there is no hard and fast test which
can be laid down" to determine fair value (see above, § 21).
§ 37. No authoritative determination of standard of value.
In Advances in Rates, Eastern Case, 20 1. C. C. R. 243,
261, decided February 22, 1911, the opinion of Interstate
Commerce Commissioner Prouty, after citing Smjrth
V. Ames (see § 24) refers to the lack of an authoritative
determination of a standard of value as follows:
The foregoing are the factors which, in the opinion of the Su-
preme Court, are to be weighed in determining the value of these
properties for rate-making purposes. When it is remembered
that information upon one and perhaps the most important of
these heads is entirely lacking, that the Supreme Court itself
has not attempted to assign a particular value to any one of
the above factors, which must be combined to produce the
result, that counsel after the most careful consideration, both
of the law and of the economic and social problems which imder-
lie this subject, are hopelessly divided ad to the relative im-
portance of these respective items, it will be seen that an3rthing
like a mathematical conclusion, or one for which a definite
reason can be assigned, is impossible. Further reflection con-
firms what this Commission, having under advisement a similar
question, said In re Proposed Advances in Freight Rates, 9 I.
C.C.R.382,404:
It is plain that until there be fixed, either by legislative enactment
or judicial interpretation, some definite basis for the valuation of rail-
road property and some limit up to which that property shall be al-
lowed to earn upon that valuation, there can be no exact determination
of these questions. In the absence of such a standard the tribunal.
Digitized by VjOOQ IC
§ 38] Faib Valxte 39
whether court or commission, which is called upon to consider this
matter, can only rely upon the exercise of its best judgment.
We must take the history of these properties and, from a
consideration of all the facts before us, arrive at some rough
notion of their value for railroad purposes.
§38. Recent decisions.
Since the decision in Smyth v. Ames in 1898 (see § 24)
the elements of value there enumerated have often been
quoted by lower courts and commissions and have often
been referred to as fixing definitely the steps to be taken
in any proceedings for the determination of fair value
for rate purposes. The Wisconsin and Washington Rail-
road Commissions, for example, in various earlier opinions
take pains to show that the various matters mentioned
in Smyth v. Ames have received due consideration. On
the other hand, the United States Supreme Court in two
recent cases has apparently given no attention to the con-
sideration of many of the factors enumerated in Smyth
V. Ames. In Knoxville v. Knoxville Water Co., 212 U. S.
1, 29 Sup. Ct. 148, 53 L. ed. 371, decided January 4, 1909,
and Willcox v. Consolidated Gas Co., 212 U. S. 19, 29
Sup. Ct. 192, 53 L. ed. 382, decided January 4, 1909,
almost the only elements of value considered were cost-
of-reproduction and existing depreciation. Even before
these two decisions the lower courts and commissions
in most cases while nominally at least considering various
elements of value have in fact apparently made cost-of-
reproduction-less-depreciation the controlling factor (see
§§31,32,72).
§ 39. Valuation standards.
While, therefore, it is established that a public service
corporation must as a general rule be allowed to charge
a rate that will produce a fair return on the fair value of
Digitized by VjOOQ IC
40 Valuation [§ 39
the property used in the service of the public, there is as
yet no authoritative determination of what constitutes
fair value. The entire subject is in a developmental
stage. Various standards and combinations of standards
are being used or advocated. The three fundamental
standards are: 1. Market value as a going concern.
2. Cost of reproduction. 3. Actual cost. Usually whether
acknowledged or not one of these three standards will
be the controlling factor. The appraiser may consider
all three factors and may claim to give them all equal
weight, but in fact, perhaps unconsciously, use the other
two factors merely to throw light on the third which is
made the actual standard. For example, cost-of-repro-
duction may be the actual standard and actual cost and
market value considered only in so far as they help to
test or confirm the estimated costK^f-reproduction. The
courts and commissions have in the main ; prudently
refrained from disclosing their real standard of value,
as they have realized the newness of the subject and the
danger of creating precedents that may compromise
future action when the entire problem has been more fully
disclosed.
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CHAPTER III
Market Value as a Standard for Rate Purposes
S 50. Usual meaning of market value.
51. Application to railroad valuation.
52. Use by Washington Railroad Commission.
53. Statement of theory by Henry Earle Riggs — Investment value.
54. Competition in its relation to market value theory.
55. Favorable location in its relation to market value theory.
56. Monopoly value.
57. Reasonable rates cannot be based on market value.
58. The misplaced or partially obsolete plant.
59. Same subject — San Francisco Water Rate Case, 1911.
60. Market value the true standard — Justice Brewer in Reagan v.
Farmers' L. & T. Co., 1894.
61. Maricet value standard impracticable — California Supreme Court in
San Diego Water Case, 1897.
62. Value as a going business concern — Circuit Judge McCormick in
Metropolitan Trust Co. v. H. & T. C. R. Co., 1898.
63. Value as a producing factor — Circuit Judge Simonton in Mathew v.
Corporation Commissioners, 1901.
64. Market value — District Judge Trieber in Arkansas Rate Cases, 1911.
§ SO. Usual meaning of market value.
An appraisal of value is usually based largely on market
price. A thing is worth what a responsible bidder will
o£fer. An appraisal is an estimate of the amount that will
normally be offered. It is thus that a piece of land is
appraised and it is thus that a public utility plant would
be appraised if it were a question of its transfer from one
private proprietor to another. The market value theory
recognizes most consistently that the business, whether
it be a gas plant or a great railroad system, must be valued
as a single unit. There is but one value and that the value
of the going business concern. Structural costs, depre-
dated condition and many other things are considered^
[411
Digitized by VjOOQ IC
42 Valuation [§ 51
but only for the purpose of more accurately gauging the
probable net mcome. If net income be guaranteed, all
questions as to costs and intangible values may be ig-
nored. Property has value as an investment only to the
extent of the present and prospective net returns. If
there are no returns, value disappears. The investment
value of ii property is the present worth of the prospective
returns. In other words, the capitaUzed probable net
return is the investment value. The capitaUzation rate
depends on the rate of interest and the degree of risk.
The probable net return and the capitalization rate deter-
mine market value, i. e., the value to the buyer and to the
seller,
§ 61. Application to railroad valuation.
John C. Lawrence, a member of the Washington Rail-
road Commission, has well stated the market value theory
of valuation, in his report, as chairman of the Committee
on Railroad Taxes and Plans for ascertaining the fair
value of railroad property, to the Twenty-second Annual
Convention of the National Association of Railway Com-
missioners, 1910:*
The most important facts on which to base a determination
of the value of a railroad property are:
First. The actual cost of construction.
Second. Cost of reproduction, new.
Third. The depreciated value.
Fourth. The amount and market value of stock and bonds
issued, with a full financial history of the road.
Fifth. The density of population and traffic.
Sixth. The nature and permanence of population and traffic.
Seventh. Facilities for doing business.
Eighth. Physical characteristics.
Ninth. The amount of earnings and operating expenses.
^ National Association of Railway Commissioners, Proceedings, 1910,
p. 139.
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i 51] Market Valxtb 43
All of the facts above named are pertinent to the inquiry as to
the market value of the property, but none are controlling.
A given railroad property may be actually worth only half as
much as it originally cost, the cost of reproduction or depreciated
value, or it may be worth double the amount in either case.
The amount and value of stocks^ and bonds may have only a
remote bearing on the question of real value, according to the
reflection of true value in such market value. The density of
population and traffic are only indications of probable amount
of business to be transacted, not necessarily the earning capacity
of the road, except when done at a remunerative rate. The
nature and permanence of population and traffic are factors
afiFecting the earning capacity of the road in the future. A road
may have ample facilities for doing business without business
offering commensurate with such facilities. The physical char-
acteristics are of more vital importance when in the presence
of a competing carrier which is operating under more favorable
conditions. It is therefore apparent that the elements named
and other elements which may appear during the progress of the
inquiry are only important steps leading to a conclusion which
may be summed up in answer to the question: "What is the
ability of the company now and in the future to earn money as
a going concern at a charge of reasonable rates?" This involves
the ability to conduct transportation, and transportation to be
conducted in proportion to that ability. The considerations
which would govern a prudent business man in the purchase of
the property, or the owners in fixing a selling price, are the same
considerations that should govern a railroad commission in de-
termining the market value of a railroad property. But prece-
dent to such a determination must come a careful and fair in-
vestigation as to the various elements eniunerated. . . .
Having a physical valuation of the property, the next step
is to determine the market value. While the physical value is
a basis for such determination, it by no means fixes the market
value. A road originally costing $5,000,000 may have been
built principally for the transportation of forest products.
Suppose the forests tributary to it have been exhausted, no
other traffic developed, and that the road has ceased to pay
Digitized by VjOOQ IC
i4 Valuation [§ 51
operating expenses, would the original cost determine its value?
Would the cost of reproduction, new, or the depreciated value
govern in such cases? Clearly not. Having as a basis the
phs^sical value, the commission must turn to a consideration of
what would fix the market value. This can be done only by the
exercise of sound judgment, and no rule for such determination
can be laid down. Fixed charges must be met, so a knowledge of
outstanding issue of bonds and other obligations is necessary.
A careful study should be made of the financial history of a road,
its stock issue, and all sources from which funds were secured for
construction purposes.
The density of population and traffic is one of the greatest
importance, coupled with permanency of population and
traffic. One road may have been built to a mining country,
with ore as a principal commodity. If the body of ore is ex-
hausted and the camp deserted such road would not have the
market value of another road, costing just the same, with
the same cost of reproduction and amount of depreciation,
but built through a fertile valley, rich in agricultural re-
sources, with a constantly increasing population and produc-
tion and with a haul of high class as well as low class com-
modities.
Other things being equal, the facilities for doing business
become an important factor. A road which has a long-
established transportation business, with industries located on
its tracks, warehouses, both public and private, to facilitate the
movement of business, is of greater value than a new road
lacking such facilities. Such facilities are an item of marked
value which a new road will require years to acquire and which
go largely to make up the ability of the company to conduct
business. **
The physical conditions under which a road is operated largely
govern the cost of conducting transportation and directly affect
the earning power of a road. If the preponderance of tonnage
movement is down grade the cost of haul is less than if the
reverse were true. The railroad having a convenient and cheap
fuel supply is of greater value than otherwise. A road may
occupy a strategic position, secure from competition or divi-
Digitized by VjOOQ IC
§ 52] Market Value 45
sion of traffic. The lower the grade and the lighter the
curvature, other things being equal, the cheaper the cost of
operation.
Having the factors going to show the ability of the carrier to
conduct business, with the amount and kind of business offering,
a study of the earnings and operating expenses will show the
ability of the company to earn money as a going concern. No
better evidence can be secured in this regard than the actual
earnings and operating expenses.
From a consideration of all of these and other facts appealing
to a commission, the market value of the railroad property will
be determined. The determination of market value as a basis
for rate making solves impossible problems presented in the
mere physical value as measured in the cost of reproduction.
Take, for instance, two competing roads between the same
terminals, one on a direct line and the other circuitous, the
latter costing very much more to construct, or reproduce. It
is apparent that competition will force an equality in rates.
How, under the theory of actual cost or cost of reproduction,
can the rates be fixed without allowing an excess on one hand,
or a deficiency on the other? Apply the theory of market value.
The road with the direct line, lower cost of reproduction, and
relatively lower operating expenses is of a higher market value
under the circumstances.
§ 62. Use by Washington Railroad Commission.
The Washington Railroad Commission in fixing the
value of the railroads of the state for rate purposes and
in a rate case involving the valuation of an interurban
electric railway, has made market value the basis. The
Conunission, following the steps indicated in Smyth
V. Ames (see § 24) has considered original cost, cost-of-
reproduction, depreciation, the amount and value of
stock and bonds, the population and density of traffic
along the line, the physical characteristics of the road and
"every element which the Commission believed an intend-
ing purchaser would consider." Thus one of its fonnal
Digitized by VjOOQ IC
46 Valuation [§ 52
findings in the valuation of the Great Northern Railway
Company is as follows: *
That from the consideration of the foregoing findings show-
ing the amomit expended for original construction of its lines,
amount necessary to reproduce the property, its depreciated
condition, the amount and value of its capital stock and funded
indebtedness, the density of traffic and volume of business along
its line, the physical condition and properties along its line, the
facilities along its line for the transa;ction of business, and all
and singular the findings hereinbefore set out, the Commission
finds that the present cash market value of the lines hereinbe-
fore mentioned and dealt with as being operated by the Great
Northern Railway Company in the State of Washington, is
the sum of $59,577,212.00.
The Commission also states that among the factors which
it has considered as adding to the market value of the rail-
way lines are (1) the docks and warehouses upon its line
whether owned by the company or by private individuals;
(2) the close proximity of coal land to the line of the rail-
road; (3) the expenditure by the company of large sums
in exploiting the resources of the country, which expendi-
ture has increased density of traffic; (4) the fact that the
lines of the company traverse timber lands which furnish
a large volimie of profitable tonnage.
The following is from the opinion of the Commission
in Paulhamus v. Puget Sound Electric Railway, decided
February 26, 1910: »
The value of defendant's property used in this service has
been found by the Conmiission, including working capital and
supplies on hand, to be the sum of $4,070,237. This valuation
' Second and Third Annual Report, Washington Railroad Commiasion,
1907-1908, pp. 127, 318.
'PaulhamuB v. Puget Sound Electric Railway, decided February 26,
1910, Fifth Annual Report, 1910, Washington Railroad Commission, p. 28.
Digitized by VjOOQ IC
§ 52] Market Value 47
was arrived at by ascertaining, after a most thorough examina-
tion by expert accomitants, the amount expended by the com-
pany in constructing its lines, which was found, exclusive (tf work->
ing capital and supplies, to be $2,933,863.69; that it would cost
to reiNToduce the property now at the present time $4,157,558
(this included an increase in the value of the right-of-way and
terminals over what it cost of approximately $770,000); ascer-
taining the depreciated condition of the property; ascertaining
the reflected value of the property as shown by the amount
and value of its stock and bonds (the method followed is set out
m the findings), found to be $3,987,376.23; ascertaining the
density of the population and trafiic and all other conditions
which in the judgment of the Ck)mmi8sion would affect the
market value of the property.
The Conunission also includes in this market value, the
value added to the railway by reason of its favorable loca-
tion and the present and prospective growth of the popu-
lation served. The Conunission says (Finding No. 19,
page 81):
That the valley so traversed is highly rich in its agricultural
possibilities, and particularly in its adaptability to the raising
of small fruits, from two to three acres being sufficient to sup-
port a family; that the growth of the cities of Seattle and Ta-
ooma, with the rapid development of the towns and valleys tra-
versed, is such as adds great value to the line of the defendant
company; that the road largely traverses the center of the dif-
ferent valleys, and it is unlikely that another electric line will
in the near future attempt to parallel this line; that the fact
that the defendant company owns the capital stock of the Ta-
coma Railway & Power Ck)mpany's line, thus giving it an entry
into the business center of the city of Tacoma, adds great value
to the line, independent of the fact of its paying reasonable
trackage tolls therefor; and its alliance with the Seattle Elec-
tric lines, by which it is able to secure reasonable traffic arrange-
ments with said lines, enabling it to enter the business portion
of the dty of Seattle, adds value to its line.
Digitized by VjOOQ IC
48 Valuation [§ 52
What this value is the Commission does not state but
presumably it is approximately the amoimt by which
the fair market value of the entire prop^y as fixed
by the Commission exceeds the cost-of-reproduction-less-
depredation. The cost-of-reproduction-less-depreciation
was $3,598,232 and the fair market value $4,070,237, so
that approximately $470,000 was the added value due to
favorable location, etc.
In 1911 the name of Washington Railroad Commission
was changed to Public Service Commission of Washington
and its jurisdiction was extended to cover all classes of
public utilities (Wash. Laws, 1911, ch. 117). The new law
regulates in imusual detail the method of making valua-
tions, following the general outline of the actual practice of
the Railroad Commission as above described. Section 92
of the act is in part as follows:
§92. Valuationof Property; Procedure. The commission shall
ascertain, as early as practicable, the cost of construction and
equipment, the amount expended in permanent improvements,
and the proporticmate amount of such permanent improvements
charged in construction and to operating expenses respectively,
the present as compared with the original cost of construction,
and the cost of reproducing in its present condition the prop-
erty of every public service company.
It shall also ascertain the amount and present market value
of the capital stock and funded indebtedness of every public
service company.
It shall also ascertain, in the case of companies engaged in
interstate business, the relative value of the use to which such
property in this state is actually put in the conduct of inter-
state business and state business respectively.
It shall also ascertain the total market value of the properly
of each public service company operating in this state, used for
the public convenience within the state.
It shall also ascertain the time intervening between the ex*
penditure of money in the cost of construction and the time
Digitized by VjOOQ iC
§ 52] Market Value 49
when returns in the shape of dividends were first received by
each of these companies.
It shall also ascertain the probable earning capacity of each
public service company mider the rates now charged by such
companies and the siun required to meet fixed charges and oper-
ating expenses, and in case of a company doing interstate busi-
ness it shall also ascertain the probable eammg capacity of such
company upon intrastate business and the sum required to
meet fixed charges and operating expenses on intrastate busi-
ness, and the relative proportion of intrastate and interstate
business, the relative proportion of the operating expenses
connected therewith, the relative proportion of the revenue
which should be derived therefrom.
It shall also ascertain the density of traffic and of population
tributary to every public service company, and the conditions
which will tend to show whether such traffic and population
are likely to continue, increase or diminish.
It shall also ascertain the existence of grades, curvatures and
other physical conditions affecting the movement of traffic and
business of common carriers.
It shall also ascertain whether the expenditures already made
by any public service company in procuring its property were
such as were justified by then existing conditions, and such as
might reasonably be expected m the immediate future, and
whether the money exptoded by such company has been rea-
scmable for the present needs of the company, and for such
needs as may reasonably be expected in the immediate fu-
ture.
The commission is hereby authorized to cause a hearing or
hearings to be held at such time or times and place or places as
the commission may designate for the purpose of ascertaining
the matters and things provided for In this section. . . .
Any company affected by the findings, or any of them, be-
lieving such findings, or any of them, to be contrary to law or
the evidence introduced, or that such findings are unfair, im-
warranted or unjust, may institute proceedings in the superior
court of the State of Washington. . . .
Said public service company or the commission shall have
4
Digitized by VjOOQ IC
50 Valuation [§ 63
the right to appeal from the decision of the superior court to the
supreme court of the State of Washington as in civil cases. . . •
The findings of the commission so filed, or as the same may
be corrected by the courts, when properly certified under the
seal of the conmiission shall be admissible in evidence in any
action, proceeding or hearing in which the state or any officer,
department or institution thereof, or any county, mimicipality
or other body politic and the public service company affected
is interested, whether arising under the provisions of this act
or otherwise, and such findings when so introduced shall be
conclusive evidence of the facts stated in such findings as of
the date therein stated under conditions then existing, and
such facts can only be controverted by showing a subsequent
change in conditions bearing upon the facts therein determined.
When the commission shall have valued the property of any
public service company, as provided for in this section, nothing
less than the market value so found by the commission shall
be taken as the true value of the property of such company
used for the public convenience for the purposes of assessment
and taxation. . . .
§63. Statement of theoiy by Henry Earle Riggs— Invest-
ment value.
The argument of Henry Earle Riggs, in his paper on
" Valuation " in the Proceedings of ^ihe American Society
of Civil Engineers, November, 1910, page 1520, points to
investment value based on net earnings imder reason-
able rates as the standard of value for rate purposes:
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. It would seem to be reasonable to interpret
the court's meaning of the term "fair value" to be. the value as
a business or commercial property, taking into account the
actual investment existing in the property, together with any
favorable conditions which would enable it to earn, on rates
which were fair and reasonable to the consumer, an income in
Digitized by VjOOQ IC
§ 54] Market Value 51
excess of a usual rate of interest on the actual investment, or
any unfavorable ones which under the same rates would reduce
its earnings to less than usual interest. If such an interpreta-
tion be allowable, it would appear to be correct practice to use
a "fair value" made up of two elements: a physical value, rep-
resenting the investment, and a non-physical value, representing
all the elements which affect that investment to give it favor-
able or unfavorable financial returns. 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?
Is not this clearly what the court had in mind in the Nebraska
Rate Case? [Smyth v. Ames, 169 U. S. 466, 18 Sup. Ct. 418,
4^ L. ed. 819, decided March 7, 1898.]
§ 64. Competition in its relation to market value theory.
The above argument both of Conmiissioner Lawrence
and of Mr. Riggs for market value as the standard of
valuation for rate purposes is applied only to railroads
and assumes the existence and desirability of competition
in the railroad business. Commissioner Lawrence refers
to the problem of valuing two competing roads between
the same terminals and assumes that the rates on thQ
shorter and less costly line should be made high enough
to permit the longer and more expensive line to compete
for the through traffic and at the same time earn a fair
return on its larger capital investment. In other words,
in order to secure the benefits of competition, the shipper
is to be compelled to pay profits on more than double
the necessary capital. Mr. Riggs probably has in mind
a similar case of competition when he refers to the value
arising from " any favorable conditions which would en-
able" the railroad ''to earn, on rates which were fair and
reasonable to the consiuner,'' an income in excess of
the usual rate of profit on the actual investment. Where
there is active competition there should be no necessity
Digitized by VjOOQ IC
52 Valuation [§ 55
for rate regulation so far at least as the general rate
schedule is concerned. But as a matter of fact the field
of active competition in transportation rates is limited.
It is well known that rate schedules are agreed upon at
conferences of representatives of the so-called competing
roads. Following the example of Massachusetts in 1882,
the New England states, New York and more recently
a few other states have practically recognized the essen-
tially monopolistic character of railroad transportation
and the disadvantage of unnecessary competition, by
requiring an official certification of '^ public convenience
and necessity" for the construction of a new road. The
only reason that can justify the building of a parallel
competing road under present policies of public control
over rates and service, is that the existing road cannot
be induced to provide adequate facilities. Under the
old regime of pseudo competition and no public control
the promoter of a competing road had no legitimate reason
for his venture unless he considered that the new road could
draw sufficient traffic at remimerative rates from the exist-
ing road to permit it to earn a fair return on its invest-
ment. He certainly had no right to assmne, however, that
the rates of a competing and more favorably situated line
would be raised in order to permit the new road to earn
a fair return. Under a regime of actual competition
rates would certainly not be based on the cost to the most
inefficient and expensively constructed competitor. This,
however, is apparently the theory that the advocates
of a market value standard would apply to the determina-
tion of rates under a system of public control.
§ 55. Favorable location in its relation to market value tiieory.
Favorable location also adds to fair value for rate pur-
poses under the market value theory. A railroad has
selected for itself the most favorable locations for its road
Digitized by VjOOQ IC
§ 56] Market Value 63
and terminals. Perhaps it follows the only available route
through a narrow pass or valley and has terminals monop-
olizing the most favorable locations. Some conceptions
of the market value theory would capitalize all such mo-
nopolistic advantages arising from favorable location. It
is argued that any competitor would have less traffic and
would necessarily have to spend more for construction,
more for operation, and much more per imit of traffic.
Rates charged by such a competitor to be remunerative
would necessarily have to be correspondingly high. It
is axgued that remunerative rates for this possible com-
petitor should serve to fix the rates of the existing road.
The net returns under rates thus fixed will be capitalized
to fix the market value and this market value may be
greatly in excess of either the actual cost or the cost of
reproduction. But by this method the rates are deter-
mined before the market value is found and therefore
the determination of market value is in fact unnecessary.
Market value is determined by income xmder reasonable
rates, and reasonable rates are determined in either of two
ways: (1) If the reproduction cost or expense of operation
is less than that of an actually competing or hypothetically
competing line, by such rates as will give a fair return
on the cost of such competing or hypothetical line. (2) If
the reproduction cost or expense of operation is equal to or
greater than that of an actually competing or hypothetic-
ally competing line, by a fair return on such reproduction
cost. In this latter case the cost and the market value
are identical.
§56. Monopoly value.
The monopoly value arising from favorable location
is not usually claimed for utilities other than railroads.
It is somewhat similar to the claim that location in the
city streets under a franchise can be capitalized for rate
Digitized by VjOOQ IC
64 Valuation [§ 57
valuation purposes. A closer parallel, however, is the case
of a water supply plant that has secured the most econom-
ical source of supply. Any competing company would
have to obtain a supply from a much more distant source,
thus greatly increasing the capital cost. It has been
claimed that in a rate case the fair value of the water plant
is not its cost but the greater cost of the new plant. This
claim was denied by District Judge Farrington in his opin-
ion in Spring Valley Water Works r. San Francisco, 192
Fed. 137, decided October 21, 1911 (quoted below, § 78).
It is inconsistent with what is believed to be the govern-
ing principle of justice and equity which forms the basis
of public service control, that rates should be increased
in order to pay a return on the capitalized value of ex-
clusive location or other monopoly advantage that repre-
sents no actual investment. A railroad exercises the right
of eminent domain to seciure its location and the right of
eminent domain can only be lawfully exercised for a pub-
lic purpose. The location secured by this method for a
public purpose cannot justly create a monopoly that will
be capitalized against the very public purpose that it was
intended to serve — ^the transportation of freight and pas-
sengers.
§ 67. Reasonable rates cannot be based on market value.
By the above method rates are based on physical cost,
but not necessarily on the cost of the road itself, but
in many cases on the cost of a competing or hypothet-
ical road. Market value has nothing to do with the rate
question as thus considered. It is only set up after the
rates are in fact determined. To be sure, the theory is
that rates are based on a fair return on the market value
of the road under reasonable rates. The impossibility
of basing reasonable rates on a market value that is itself
determined by reasonable rates is apparent. It is a clear
Digitized by VjOOQ IC
§ 58] Mabkest Value . 55
case of reaaoning in a circle. We have the evident ab-
surdity of requiring the answer to the problem before we
can undertake its solution. The advocates of the market
value theory cannot really mean what they say. Market
value is not really a part of the process but the final result.
It includes in many cases a capitalization of certain
monopoly profits and the monopoly value thus created
is set up as justifying the higher rates which have in
fact created the monopoly value. A difficulty in the
consistent application of the market value theory is il-
lustrated by the following: The Washington Railroad
Commission determines the present cash market value of
the railroad (see § 52) and then fixes rates so as to allow the
company to earn a return of 7% (see § 769) on this mar-
ket value. The query is whether this determination does
not immediately create a new and higher cash market value
and therefore require an immediate increase in the rates
just established. This will be true if the capitalization rate
which actually determines market value is lower than 7%.
If ^ for example, the capital of the railroad in question con-
sists of two-thirds bonds and one-third stock, and if the
5% bonds sell at par and the stock can be sold on a 7%
income basis, then the present cash market value of this
road will be increased under the rates and rate of return
fixed about 17% above the '^present cash market value"
fixed by the Conunission.
§ 68. The misplaced or partially obsolete plant.
While it is clear that market value as above considered
18 not a proper general standard of value for rate purposes
it is possible that it may have some merit in the valuation
of a misplaced or partially obsolete plant. This is referred
to the report of Commissioner Lawrence of the Washing-
ton Railroad Commission above quoted (§ 51) and is
also discussed in the report of the Valuation Committee
Digitized by VjOOQ IC
66 Valuation [§ 58
of the National Association of Railroad Commissioners,
in October, 1911, as follows: *
The misplaced or partially obsolete plant or road is the one
that causes greatest difficulty in valuations for any purpose.
A waterworks plant has been built for a village too small
to support it and the population of the village instead of
increasing as expected actually decreases. A railroad has
been constructed chiefly to carry coal from certain mines or
lumber from a certain district. The coal or the timber be-
comes exhausted leaving a railroad that cannot pay a fair
return on its actual cost or its reproduction cost no mat*
ter what the scale of rates charged. A street railway is con*
structed chiefly to carry passengers to a certain terminal, but
currents of travel having changed, it can not possibly earn
interest on its actual cost. Under such conditions the plant
or line as a whole must be recognized as partially obsolete,
and the best gauge of its present depreciated value will in
many cases be its fair market value. Cases of this kind are
frequently met with in valuation for tax purposes. A gen-
eral reduction in the rates of a road or plant of this kind seldom
comes up for official conisideration but it very frequently hap-
pens in valuing any comprehensive ridlroad or street railway
system for rate purposes, that there are certain lines that are
partially obsolete though the system as a whole is earning a
profit. For such partially obsolete, or partially used lines, neither
actual cost nor reproduction cost, nor reproduction cost less
existing physical depreciation, furnish any basis for fixing fair
value for rate purposes. The value that will be most appro-
priate will be a value based on the earnings of the line as a part
of the system and will thus be closely related to market or
commercial value. But though in a rate case we can, as above,
base the value of a particular part of a comprehensive system
on earnings or market value, we can not base the value of the
whole system on market value, as the market value depends on
the scale of rates charged, and the rate scale is the question at
* National Association of Railway Commissioners, Proceedings of the
Twenty-third Annual Convention, October, 1911, p. 148.
Digitized by VjOOQ iC
§ 59] Market Value 67
issue. The market value of the system will depend largely on
the net return that may be earned under the rate scale allowed.
Rates in the case of the misplaced or partially obsolete
plant or road cannot be based primarily on the value of
the property but on what the service is reasonably worth
and this in most cases is the amount that the consumer
can reasonably afford to pay. The determination of
the amoimt that the consimier can reasonably afford
to pay is a process for which no rules can be laid down.
It is usually determined in practice by noting the effect
of rate variations on the volume of traffic. The net return
resulting under reasonable rates as thus determined may
be capitalized to determine the market value of the plant
or road; but it is to be noted that value is here based on
rates, not rates on value.
§ 69. Same subject— San Francisco Water Rate Case, 1911.
In the case of Spring Valley Water Works v. San Fran-
cisco, 192 Fed. 137, decided October 21, 1911, District
Judge Farrington states that in certain cases "fair value"
means the value upon which a fair return can be earned
at reasonable rates, and seems to recognize the need of a
special standard in the case of the misplaced or partially
obsolete plant. Judge Farrington says (at pages 154-155) :
It is impossible to consider the constant use of the word
"fair" or the word "reasonable," in connection with value, by
all the federal courts and the courts of this state in practically
every recent statement of this rule, without feeling that regard
must be given to the service performed by the property; that
reasonable value and fair value are not always and under all
conditions the precise equivalent of full actual value, or the
value which would be awarded in condemnation proceedings;
that the value upon which a fair return is due is the value which
under all the circumstances is reasonable and fair as between
the public and the person who has volimtarily devoted his
Digitized by VjOOQ iC
^58 Valuation [§ 60
property, or some podion or use thereof, to public conve-
nience.
§60. Market yalue the true standard— Justice Brewer in
Reagan v. Farmers' L. Ik T. Co., 18M.
In Reagan v. Farmers' Loan & Trust Company, 154
U. S, 362, 14 Sup. Ct. 1047, 35 L. ed. 1014, decided May 26,
1894, Justice Brewer says (at page 410) :
The equal protection of the laws — ^the spirit of conmion justice
— ^forbids that one class should by law be compelled to suffer
loss that others may make gain. If the State were to seek to
acquire the title to these roads, under the power of eminent
domain, is there any doubt that constitutional provisions
would require the payment to the corporation of just com-
pensation, that compensation being the value of the prop-
erty as it stood in the markets of the world, and not as pre-
scribed by an act of the legislature? Is it any less a departure
from the obligations of justice to seek to take not the title but
the use for the public b^iefit at less than its market value?
§61. Market value standard impracticable —California Su-
preme Court in San Diego Water Case, 1897.
San Diego Water Company v. City of San Diego, 118
Cal. 556, 50 Pac. 633, decided October 9, 1897, is a case
involving a valuation for rate purposes. The lower court
held the municipal ordinance imconstitutional but was
reversed by the Supreme Court and the cause remanded
for a new trial. Judge Van Fleet in the majority opinion
says (at page 568) :
The judicial test of market value depends upon the fact
that the property in question is marketable at a given price,
which, in turn, depends upon the fact that sales of similar
property have been and are being made at ascertainable prices.
But such property as this is not so sold, at least not often
enough to furnish a fair criterion; and the very fact of govern-
mental regulation would necessarily control the price. Until
Digitized by VjOOQ IC
§ 62] Mabkst Value (SO
the rates are fixed, no one can say how much the property would
sell for, and therefore that price cannot be ascertained as a
basis for fixing those rates.
§ 62. Value as a going business concern— Circuit Judge Mc«
Cormick in Metropolitan Trust Co. v. H. Jk T, C. R. Co.,
1898.
Metropolitan Trust Company v. Houston & T. C. R.
Co., 90 Fed. 683, decided December 1, 1898, United States
Circuit Court, Western District, Texas, was a suit for
an injunction involving railroad rates adopted by the
Texas Railroad Commission. Circuit Judge McConnick, ,
in his opinion, considers at some length the basis of valu-
ation in rate matters and states that the valuation sub-
mitted by the railroad commission is defective in that it
fails among other things to make proper allowance for
"favorable location," "seasoning," "established busi-
ness," "good will" and "lost interest on investment")
during some twenty years during which the railroad/
was not earning a fair return. He considers that cost
of reproduction is not a proper basis but that the railroad
should be valued as a going business concern on the same
basis as if it were a valuation for condemnation purposes.
He says (at page 687) :
It seems to be clear from the answer of the commission, the.
tone of the affidavits which it ofifers in support of its answer, and
the argument of the attorney general and the assistant attorney
general who represented it on this hearing, that in estimating
the value of this railroad property no allowance was made for
the favorable location of the same, in view of the advance in,
prosperity of the country through which it runs, and the incre-^
ment to its value due to the settling, seasoning, and permanent
establishment of the railways, and to the established business
and the good will connected with its business, which has been
established through a long series of years, and all of which ought
reasonably to be considered in fixing the value of the property
Digitized by VjOOQ IC
60 Valuation [§ 62
and the capitalization upon which at least it is entitled to earn,
. and should pay, some returns by way of interest or dividends.
This is practically the oldest railroad in the state. A few miles
of another road were built earlier, but this road, running through-
out the whole course of its main line through what is now the
most populous and best-developed portions of the state, and
still rapidly increasing in population and development, has
established a business that would not and could not be disre-
garded in estimating the value of the railroad, if considered
nolely as a business property and venture. It cannot be so con-
sidered, because of its quasi public nature. Its duties, its ob-
ligations, and its liability to control are elements that must
be considered. As popularly expressed, the rights of the people
— the rights of shippers who use as it as a carrier — ^have to be
regarded; but, as judicially expressed, these last have to be so
regarded as not to disregard the inherent and reasonable rights of
the projectors, proprietors, and operators of these carriers. . . .
In countries conditioned as Texas has been and is, such a rail-
road property and business cannot be reproduced, except sub-
stantially in the same manner in which this has been pro-
duced; that is, by a judicious selection of location, by small
beginnings, and gradual advance throi^h a number of years,
more or less, of unproductive growth. The particular location
of this road, of course, cannot be reproduced, and it cannot be
appropriated by another private or quasi public corporation
carrier by the exercise of the state's power of eminent domain.
And, even if the state should proceed to expropriate this prop-
erty for the purpose of taking the same to itself for public use,
the location of this road cannot be appropriated, any more than
any other property right of a natural person or of a corporation
can be appropriated, without just compensation. It is there-
fore not only impracticable, but impossible, to reproduce this
road, in any just sense, or according to any fair definition of
those terms. And a system of rates and charges that looks to a
valuation fixed on so narrow a basis as that showii to have been
adopted by the commission, and so fixed as to return only a
fair profit upon that valuation, and which permits no account
for betterments made necessary by the growth of trade, seems
Digitized by VjOOQ iC
§ 62] Market Value 61
to me to come clearly within the provision of the fourteenth
amendment to the constitution of the United States, which for-
bids that a state shall deprive any person of property without
due process of law, or deny any person within its jurisdiction the
equal protection of the laws. It is true that railroad property may
be so improvidentJy located, or so improvidently constructed
and operated, that reasonable rates for carriage of freights and
passengers will not produce any profit on the investment. It is
also true that many railroads not improvidently located, and
not improvidently constructed, and not improvidently operated
may not be able, while charging reasonable rates for carriage
of freight, to earn even the necessary running expenses, including
necessary repairs and replacements. And there are others, or
may be others, thus constructed and conducted, which, while
able to earn operating expenses, are not able to earn any ap-
preciable amount of interest or dividends for a considerable time
after the opening of their roads for business. This is true now of
some of the roads, parties to these bills. At one time or another,
and for longer or shorter times, it has been true, doubtless, of
each of the roads that are parties to these bills. Promoters and
^nroprietors of roads have looked to the futiu^, as they had a
right to do, and as they were induced to do by the solicitation
of the various communities through which they run, and by
various encouragements offered by the state. The commission,
in estimating the value of these roads, say that they included
interest on the money invested dining the period of construction.
This is somewhat vague, but the ** period of construction " men-
tioned is probably limited to the time when each section of the
road was opened to the public for business. And even if ex-
tended to the time when the road was completed to Denison and
to Austin in 1873, nearly 20 years after its construction was
begun at Houston, it would not cover all of the time, and
possibly not nearly all of the time, in which the railroad com-
pany and its predecessors have lost interest on the investment.
The estimate made on behalf of the railroad in this case of the
cost to that company and to its predecessor company of the
railroad property, and the business of that company as it exists
to-day, may not be exactiy accurate, — clearly is not exactiy
Digitized by VjOOQ IC
92 Valuation [§ 63
accurate; but it seems to me that it is not beyond the fair value
of the property, as it is shown to have been built up and consti-
tuted, and to exist to-day as a going business concern, and that
such rates of fare for the carriage of persons and property as are
reasonable, considered with reference to the cost of the carriage
and the value of the carriage to the one for whom the service is
rendered, cannot be reduced by the force of state law to such
a scale as would appropriate the value of this property in any
measiu*e to the use of the public without just compensation
to the owners thereof, and would deprive the owners thereof
of the equal protection of the law guarantied by the constitution
of the United States, as cited.
§ 63. Value as a producing factor— Circuit Judge Simonton in
Mathew v. Corporation Commissioners, 1901.
In Mathew v. Board of Corporation Conmiissioners
of North Carolina, 106 Fed. 7, decided February 5, 1901,
the reasonableness of certain freight rates fixed by the
North Carolina Corporation Commission was involved.
The special master who heard the case reported in favor
of sustaining the rates, and his report was confirmed by
Circuit Judge Simonton, who, in the course of his opinion,
says (at page 9) :
The basis of all calculations as to the reasonableness of rates
is the fair value of the property used for the convenience of the
public, — ^not its cost, nor the amount of money expended upon it,
but its value as a producing factor, taking into consideration
its location, character of the country through which it passes,
and the reasonable expectation of business coming to it. The
railroad company is entitled to a fair return upon the value of
the property, ascertained in this way, and it is not entitled to
exact from the public more than this. To this question, so
difficult in its solution, and so often, after the best effort, imsat-
isfactory in its result, the special master devoted much consider-
ation. He puts the value of the railroad property a little below,
and calls it, in round numbers, $3,000,000. It may have —
Digitized by VjOOQ IC
'§ 64] iARKET Valtje 63
indeed, probably has — cost more than this. But, in estimating
the value of the property, we must take, not what was its value
in the past, nor what it cost, nor what it would cost to duplicate
it, nor its probable futiue value, but the estimate must be based
on its present value.
§ 64. Market yalue— District Judge Trieber in Arkansas Rate
Cases, 1911.
In re Arkansas Rate Cases, 187 Fed. 290, decided May 3,
1911, United States Circuit Court, is a suit to enjoin the
enforcement of freight and passenger tariffs promulgated
by the Arkansas Board of Railroad Commissioners. In
granting a permanent injunction District Judge Trieber
says (at pages 310, 319) :
By the acts of comjdainants the court is relieved of a very
difficult problem, that of the valuation of the property. In the
bills of complaint the railroads only ask for compensatwy
rates on the basis of valuation according to the assessment of
their property for taxation by the state of Arkansas made by
the State Board of Railroad Assessors. Its reasonableness is,
of course, conceded by the defendants, and therefore there is no
necessity for the court to determine what rules should govern in
ascertaining what the investments on which complainants are
entitled to a reasonable compensation are. It is proper to
state here that it is agreed by the parties that the assessments
for taxation in the state of Arkansas are on a basis of 50 per cent,
of the real value of the property, and that these assessments
were made on that basis. For this reason the assessments must
be doubled to ascertain the real value of the property. The
values of the two roads in this State thus assessed, when
doubled, are:
Iron Mountain $39,986,564
Southwestern 16,023,090
. . . The value of every investment or property is measured, .
to a large extent at least, by the value of its use, not by its use
divorced from its value. The value of a railroad for taxation, it
has been uniformly held by the courts, may properly be deter*
Digitized by VjOOQ IC
*64 Valuation [§64
mined by the value of its bonds and stocks. Without citing the
numerous cases decided by the courts, both state and national,
approving this method of assessing railroad, telegraph, and other
property of this nature, the following may be referred to: State
Railroad Tax Cases, 92 U. S. 575, 23 L. ed. 663; Kentucky Rail-
road Tax Cases, 115 U. S. 321, 6 Sup. Ct. 57, 29 L. ed. 414; .
Western Union Telegraph Co. v. Massachusetts, 125 U. S. 530, 8
Sup. Ct. 961, 31 L. ed. 790; Pulhnan Co. v. Pennsylvania, 141
U. S. 18, 11 Sup. Ct. 876, 35 L. ed. 613; Columbus Southern
Railway Co. v. Wright, 151 U. S. 470, 14 Sup. a. 396, 38 L.
,ed. 238; Pittsburgh, etc., R. R. Co. v. Backus, 154 U. S. 421,
14 Sup. Ct. 1114, 38 L. ed. 1031; Adams Express Co. v. Ohio,
^166 U. S. 186, 17 Sup. Ct. 604 (41 L. ed. 965), where the court
said:
** Whatever property is worth for the purpose of income and
sale, it is worth for the purpose of taxation."
And this is the rule sanctioned by the Supreme Court of
Arkansas. Wells-Fargo Express Co. v, Crawford County, 63
Ark. 676, 40 S. W. 710, 37 L. R. A. 371.
This is evidently the rule recognized and acted on by the
railroad assessing board of the state of Arkansas, as shown by
the evidence in this case. The main line of the Iron Mountain
Railroad is practically a water-level road — ^no mountains to cross,
no rocks to blast or tunnels to excavate, and the leading com-
mercial cities and industries of the state along its line. On the
other hand, the White River branch of that road was the most
expensive road ever constructed in the state. Miles of it had to
be cut out of rock, and tunnels cut through rocky mountains.
There are no laige cities along its line, and the country but
sparsely settled. Owing to the heavy grades and the many
curves, made necessary by the topography of the country, it.
cannot possibly carry as many cars to a train and transport
freight as economically as the main line. The state officials,
charged by law with the duty of assessing the property, must
have taken these facts into consideration when they assessed
these railroads. The White River branch, in spite of its great
cost, was in 1907 valued by that board at $19,000 per mile, and
assessed on the basis of 50 per cent, of its value at $9,500, while
Digitized by VjOOQ IC
i ©4] Market Value 65
the main line was valued at $45,000 per mile, and assessed at
50 per cent, of that sum, at $22,500 per mile.
For these reasons, the earning capacity of a railroad is the
most important factor to be taken into consideration in de-
termining its value. As shown above, it has been taken into con-
sideration by the assessing officers of the state, and should be
taken into consideration for the purpose of determining the
apportionment of values in this case. If, by reason of the higher
rates allowed by the state tariff, the net earnings of the property
are increased, the value ojf the property is correspondingly in-
creased, and the assessment for taxation made accordingly.
The foregoing, while apparently an argument for the
general use of market value as a basis of valuation, is in
the above connection made with reference only to the
apportionment of values as between intrastate and inter-
state traffic. The statement is made in justification of a
revenue basis rather than a ton mileage basis for the ap-
portionment of property value between interstate and
intrastate traffic.
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CHAPTER IV
Cost of Reproduction as a Standard of Value for Rate
Purposes
( 70. Aiguments advanced.
71. Fluctuations in railroad costs — Minnesota rate dedsions.
72. Trend of recent decisions.
73. Identical reproduction of existing plant.
74. Identical reproduction— Wm. H. Biyan on waterworks i^ipruaab.
75. Equally efficient substitute plant.
76. Substitute plant — Maine water plant condemnations, 1902-1904.
77. Substitute plant — Columbus, Ohio, Electricity Rate Case, 1900.
78. Substitute plant— Spring Valley Water Case, 1906.
79. Substitute plant — Discussion by J. £. ^^^oughby.
80. Substitute plant — Discussion by C. L. Corey.
81. Cost under present or original conditions.
82. Present or original conditions— Discussion before American Sode^
of Civil Engineers, 1911.
83. Present or original conditions— St. Louis Public Service CommiB-
sion, 1911.
84. Present or original conditions — Conclusion.
§ 70. Arguments advanced-
Strong arguments have been advanced for the use of
cost of reproduction as the standard of value for rate
purposes. It is asserted that what the public is entitled
to is service at a rate of charge sufficient only to pay a
fair return on the investment that would be required
at present to furnish this service; and conversely what
the company is entitled to receive is a fair return on the
capital investment that it or another company would
have to expend at present in order to provide the service.
A rate of charge measured on this basis corresponds to
the present economic cost of the service. Economically
considered; the present capital investment is the cost at
[66]
Digitized by VjOOQ iC
§ tl] Cost o^ Reproduction 67'
present prices of land, labor and materials of the existing
property devoted to the service of the public, less ah al-
lowance for existing depreciated condition, i. e., the cost-
of-reproduction-less-depreciation. But there are great
fluctuations in the price of land, labor and materials
as well as changes in the physical, poUtical and financial
conditions imder which public utility enterprises are
organized and constructed. If present cost of duplication
is made the basis of rate regulation all of these changes
and fluctuations affecting present cost result in an un-
earned or unmerited gain or loss either to the consumer'
or to the investor. For a further discussion of this prob-
lem see below, §§ 100-101.
§ 71. Flttctoations in railroad costs— Minnesota rate decisions.
Two railroad rate cases in Minnesota, one in 1897
and the other in 1911, serve to point out the fluctuation
in railroad costs. In both cases the court has neverthe-
less used present reproduction cost rather than actual
cost as the standard of value. In 1897 the general price
level was low while in 1911 it was high and, moreover,
the growth and prosperity of the state had greatly in-
creased land values.
The case of Steenerson v. Great Northern Railway
Company, 69 Minn. 353, 72 N. W. 713, decided October
20, 1897, Supreme Court of Minnesota, involves the
valuation of a railroad for rate purposes upon a reduction
of rates by the Minnesota Railroad and Warehouse Com-
mission. Judge Canty, in delivering the opinion of the
court which reversed an order of the lower court im-
favorable to the Commission's determination and ordered
a new trial before the lower court, says (at page 715) :
Again, the railroad may have been constructed years ago,
when iron rails cost 185 per ton, and everything else in pro-
portion, or it may have been constructed yesterday, when
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68 Valuation [| T1
steel rails cost but $16 per ton, and everything else nearly in
proportion. Counsel for the railway company dwell much
upon the original cost of the older portions of these lines of
road. If a railroad was built 30 years ago at a cost of $40,000
per mile, and another one equally as good was built within a
year through the same territory at a cost of $12,000 per mile,
on what principle should it be held that the old road is entitled
to 3i times as much income as the new road? No guaranty
was ever given by the state to the old road that the price of
materials and the cost of construction would not decline, op
that capital invested in railroads should not be subject to
'tike vicissitudes as capital invested in other enterprises. Mod-
em improvements and other causes have continued to reduce
the cost of construction of all kinds of new plants, and to se-
duce the value of old plants, or render them wholly worthless,
and the state did not guaranty that those causes should not
in like manner affect the capital invested in railroads. Then
the material question is not what the railroad cost originally,,
but what it would now cost to reproduce it. . . . Then the
burden is on the railroad company to show that the rates fixed
by the Commission are imreasonable, and for this purpose
the original cost of the road, the amount of its present fixed
charges, and its history, are material only so far as they show
what it would now cost to reproduce the railroad.
Though in this case the Supreme Court of Minnesota
took strong ground in favor of cost of reproduction as a
basis of fair value for rate purposes, it adopted a rule as
to rate of return to be allowed on terminal lands that to a
large extent serves to offset the benefit that would other-
wise accrue to a railroad or other public utility from in-
crease in land values.^ The court also states that it has
not been necessary to consider for the purposes of this
case the important fact that the railroad had received a
valuable land grant from the state.
In 1911 the valuation of Minnesota railroads for rate
1 Quoted below, § 120.
Digitized by VjOOQ IC
$ 72] Cost op REPROfttJcuON 60
purpofies again came up, and in Shepard v. NorUiem
Pacific Railway Co., 184 Fed. 765, decided April 8, 1911,
Circuit Judge Sanborn said (at pag^ 803) :
The master found the original cost of the acquisition and
construction of the entire railroad systems of each of the com-
panies and the proportion thereof assignable on a track mileage
basis to Minnesota. The amoimts thus found proved to be
much less than the values ultimately found by the master,
and for this very good reason: These railroads were pioneers;
they were built in large part over the prairies of Minnesota
before they were settled and before many of the existhig
towns, villages, and cities along their lines came into existence.
A large part of the right of way of the Northern Pacific Com- '
pany was granted to it by the nation. The cost of rights of
way from 5 to 40 years ago through wild lands, and through
towns and villages whose population and the value of the prep-
ay in which have since been multiplied by from 2 to 10, is
obviously no criterion of the value of those rights of way in
1908, when they were used under these fares and rates and when
agricultural lands in Minnesota were worth from S35 to SlOO
an acre, and rights of way and lands for yards and sites for
stations in cities Uke St. Paul and Duluth have wonderfully
increased in value. It is a fair return upon the reasonable
value of their Minnesota f»*operty in 1908 to which these
companies were entitled, and the cost of that property at
times varying from 5 to 40 years ago may be some evidence;
but it is certainly no criterion of its value in that year. In
view of these facts the master rightly decided that the cost
of reproducing this property new was a more rational and
reliable measure of its real value than the original cost of its
aequisitkm and construction or the market values of the stocks
and bonds of the companies, and upoif that basis he made his
i 7S. Tt«id of recant decisions.
The general trend of recent decisions has been to make
rq>roduction cost the sole or controlling basis of value
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70 Valuatiom [1 72
for rate purposes.^ Some courts plainly state that in their
opinion actual cost, capitalization and other factors are to
be considered only to the extent that they may throw light
on the cost of reproduction or existing depreciation. In
support of this position the opinions of the Supreme Court
of the United States are cited that indicate that it is the
"present value" of the property that is to be determined.
Thus in Smyth v. Ames,' the reference is to "the fair
value of the property being used ... for the convenience
of the public"; in San Diego L. and T. Co. v. National
City * it is "present value"; in the same case on appeal
to the United States Supreme Court ^ Justice Harlan
refers to "reasonable value of the property at the time
it is being used for the public"; this is quoted as settled
law by Justice Holmes in 1903 * and by Justice Peckham
in 1909 in Willcox v. Consotidated Gas Co.^ It is argued
(see below, § 111) that this constant use of the present
* San Diego Land and Town Co. v. National City, 74 Fed. 79, decided
May, 1896 (see above, ( 22); Consolidated Gas Co. v. City of New York,
157 Fed. 849, decided December 20, 1907 (see below, ( 111); Pioneer Tel.
& Tel. Co. V. Westenhaver, 29 Okla. -— , 118 Pac. 364, decided Janu-
ary 10, 1911 (see above, { 32); Spring Valley Water Co. v. San Francisco,
165 Fed. 667, decided October 7, 1908 (see above, (35); Cedar Rapids
Gas light Co. v. Cedar Rapids, 144 la. 426, 120 N. W. 966, 968, decided
May 4, 1909 (see above, ( 31) ; Lincoln Gas & Electric Light Co. v. Lincoln,
182 Fed. 926, decided April 6, 1909, reversed and remanded on other
grounds, 223 U. S. 349, decided February 19, 1912; Venn^ Co. p.
Urbana Waterworks, 174 Fed. 348, decided November 6, 1909; Will-
cox V, Consolidated Gas Co., 212 U. S. 19, 29 Sup. Ct. 192, 53 L. ed.
382, decided January 4, 1909 (see above, §30); Knoxville v, Knoxville
Water Co., 212 U. S. 1, 29 Sup. Ct. 148, 53 L. ed. 371, decided Jan-
uary 4, 1909.
> 169 U. 8. 466, 544-547, 18 Sup. Ct. 418, 42 L. ed. 819, decided March 7,
1898. See above, § 24. •
* 74 Fed. 79, decided May 4, 1896. See above, ( 22.
» 174 U. S. 739, 19 Sup. Ct. 804, 43 L. ed. 1154, decided May 22, 1899.
See above, § 25.
* San Diego Land and Town Co. v. Jasper, 189 U. S. 430, 23 Sup. Ct
571, 47 L. ed. 892, decided April 6, 1903.
' 212 U. S. 19, 29 Sup. Ct. 192, 53 L. ed. 382.
Digitized by VjOOQ iC
§ 73] Ck)ST OF Rbproduction 71
tense by the Supreme Court in referring to fair value for
rate purposes must at once exclude actual cost or original
cost from having any controlling influence in the deter-
mination of fair value. Under this interpretation ' ' present
value" must be based either on market value or repro-
duction cost, and as market value is not usually considered
a fair or possible standard for rate pmposes, reproduction
cost is turned to as the only available standard. This
line of argument would be more convincing were it not
for the fact that in the leading case of Smyth v. Ames,
in which the present value principle is laid down it is
also distinctly stated that both original cost and repro-
duction shall be considered in determining fair present
value, and there is no indication that either of these factors
should be given a controlling influence (see above, § 24).
While it is undoubtedly true that the trend of recent
decisions in the lower courts is to make reproduction
cost the sole or controlling basis of value for rate pur-
poses, it is certainly too early to state this as the settled
rule of law. The whole subject of valuation is still in a
developmental stage. The Supreme Court of the United
States has wisely refrained from laying down a hard and
fast rule that might have to be reversed when all the
factors of the problem have been more clearly dis-
closed.
i 73. Identical reproduction of existing plant
There are a number of different conceptions of the cost
of reproduction method: 1. Cost of reyrodv^ctUm may mean
the cast of a siAstantiaJly identical reproduction of the eah
isHng plant. This is the usual method. It does not mean,
however, that apparatus of antiquated pattern will be
exactly duplicated but that it will be assiuned to be
replaced by the nearest modem substitute. Likewise
the most economical and equally serviceable materials
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72 Valuation [§ 74
will generally be used; in some cases, for example, con-
crete will take the place of masonry construction.
§ 74* Identical reproduction— Wm. H. Bryan on waterworks
appraisals.
William H. Bryan, in his discussion of a paper on ^^Going
Value" by John W. Alvord before the American Water
Works Association, Proceedings of 1909, p. 275, says:
The reproduction theory assumes that the existing plant
in whole or m part is suited to the present-day needs of the
community. The value of a service cannot exceed the cost
to the city of serving itself, plus a reasonable profit conmien-
surate with the responsibility and risk involved. In so far
therefore as the plant as it stands is well adapted to that serv-
ice it is entitled to a fair return. But worn-out and discarded
parts have no part in present performance, and should have
been covered by past earnings. They represent no present
value, however necessary they may have been earlier. Nor
can present values be saddled with errors of judgment result-
ing in unwise expenditures, unless it is clear that these or sim-
ilar outlays would accompany the duplication of the plant
to-day. . . .
Nor need the plant to be duplicated be an exact counter-
part of the existing plant, except so far as it is adapted to ex-
isting conditions. Real estate, buildings, machinery, pipe
lines, material and supplies — ^beyond the present or reason-
ably early needs of the system — should not be considered.
The Wisconsin law covers this admirably in its use of the terms
'' actually used and useful for the convenience of the public."
Neither is it proper to figure on obsolete and expensive op-
paratus or material. Antiquated pumping engines which could
only be actually duplicated by making new patterns; and ma-
sonry for which better and cheaper concrete would now be
used, are examples.
§ 76. Equally efficient substitute plant
2. Cost of reproduction may mean the cost of a substitute
Digitized by VjOOQ IC ^
§ 76] Cost op Reproduction " 73
plant of the most modem, approved design capable of per-
ftjrming the same service as the existing plant. If the old
plant were wiped out, what would it cost at present to
construct a plant capable of performing the service now
performed by the old plant? In the case of a water
plant, perhaps an entirely new source of supply would
be used and the distribution system radically changed;
in the case of a gas plant, a different process of production
employed and a few large gas holders > substituted for
many small ones; in the case of an electric plant, iBXger
units of production employed; in the case of a railroad,
there might be a radical relocation and realignment of
roadbed, and important changes in methods of construc-
tion. The present value of the old plant is measured by
the cost of an equally efficient new plant less an allowance
for the depreciated condition of the old plant. This
seems to be the most logical method of arriving at present
structural value. One difficulty in applying it arises from
the fact that in many cases it is exceedingly difficult
and expensive to determine on an equally efficient sub-
stitute plan. Nevertheless there are usually certain ob-
vious changes in design that would assuredly be made
in any new plant. In the gas rate case of Capital City
Gaslight Company v. City of Des Moines, 72 Fed. 829,
844, decided January -8, 1896, District Judge Woolson
states that the court has based its valuation on the es-
timated cost of an equally efficient plant.
176. Substitute plant— Maine water plant condenmationsy
1902-1904.
In Brunswick and T. Water District v. Maine Water
Company, 99 Me. 371, 59 Atl. 537, decided December 14,
1904, the Supreme Judicial Court of Maine laid down
rules to govern appraisers in making a valuation of prop-
erty of the Maine Water Company for purposes of pur-
Digitized by VjOOQ IC
74 Valuation [§ 76
chase by the Brunswick and Topsham Water District.
The instructions were given on an appUcation of the
petitioner, in accordance with the provisions of the special
act providing for purchase. The court, while complying
with the provisions of the statute, expresses its apprecia-
tion of the possible diflSculties if not dangers in attempt-
ing to formulate rules which are to be applied to facts
not yet ascertained. In discussing the question of an
equally efficient plant Judge Savage says (at page 543) :
Now, such a commimity is, we think, entitled to the bene-
fit of such natural and sufficient facilities for procuring pure
water as exist in its vicinity. Communities are in every respect
entitled to the benefit of existing natural advantages.
It therefore seems to be reasonable that a public water serv-
ice company undertaking to supply a community with water
is bound to do so wisely and economically. It is bound to
take advantage of practicable natural facilities. If there is
more than one source of supply, other things being equal, the
community is entitled to have the least expensive one used.
So long as the company enjoys practically exclusive franchises,
so long it must afford the community the benefit of the con-
ditions which nature has provided for them. For instance,
if water can profitably be served from a nearer source of supply
at a certain rate, the company ought not to be permitted to
charge a higher rate based upon the expense of bringing it
from a farther and more expensive source. And this even if
in attempting to serve this and other conmiunities together
it might be more profitable to the company to do so.
The above is the second of two similar cases. In the
earlier case, Kennebec Water District v. City of Water-
ville, 97 Me. 185, 54 Atl. 6, decided December 27, 1902,
Judge Savage had made a statement that is not entirely
consistent with the above. He says (at page 19) :
We think the inquiry along the line of reproduction should,
however, be limited to the replacing of the present system by
Digitized by VjOOQ IC
§ 77) Cost of Reproduction 75
one substantiaUy like it. To enter upon a comparision of
the merits of different systems — to compare this one with
more modem systems — would be to open a wide door to speo-
ulative inquiry, and lead to discussions not germane to the
subject. It is this system that is to be appraised, in its present
condition and with its present efficiency.
§ 77. Substitute plant— ColumbuSyOhiOySlectricity Rate Case,
1906.
In the case of Columbus Railway and light Company
V. City of Columbus, No. 1206, in equity, Circuit Court
of the United States, Report of Special Master T. P.
linn, June 8, 1906, an application was made for an in-
junction against the enforcement of a city ordinance
reducing electricity rates. The special master reported
in favor of a permanent injunction and his report was ap-
proved by the court without opinion. In this case com-
petition had been succeeded by the merger of competing
plants and the city claimed that a E^ngle system could be
constructed at a less cost than the reproduction cost of
the three existing generating plants. The master refers
to the testimony of the city^s witnesses tending to show
the cost of an equivalent new and modem plant, but states
that this testimony is of little service. He does not,
however, state definitely to what extent, if any, he has
considered the possible smaller cost of an equally efficient
modem system in fixing the fair value of the existing
plant.
§ 78. Substitute plant —Spring Valley Water Case, 1908.
In Spring Valley Water Co. v. San Francisco, 165 Fed.
667, decided October 7, 1908, it was sought to restrain
the enforcement of water rates fixed by the board of
sup^risors of San Francisco, and an injunction pending
the litigation was granted. District Judge Farrington
says (at page 691):
Digitized by VjOOQ IC
76 Valuation [{ ?•
The owner of private property sets the price at which othen
may buy or use it; he cannot be compelled to accept less; this
18 his right of contract; but when he devotes his property to
public use, he must submit to the right of the public to reg-
ulate his compensation for such use down to what is just both
to himself and to the public, and that compensation is to be
1t)ased, not on the cost of the next available substitute, but
on a fair, reasonable value of the property at the time it is
used for public convenience. While the cost of a substitute
system may be considered in finding the reasonable value of
the Spring Valley plant, it cannot be a controlling element.
Otherwise^ by securing control of all available sources from
which water can be brought to San Francisco, the company
might force a greatly exaggerated value upon its plant for
rate-fixing purposes, and thus absolutely defeat the very object
of government regulation.
f 79. Substitute plant—Discussion by J. B. WWov^hj.
J. E. Willoughby, in a discussion of valuation," says:
The idea of cost of reproduction is not synonymous with the
idea of the cost of building a railway capable of serving the
same transportation purpose. If all our railways were to be
built anew, in the light of our present knowledge, and with
our present traffic ofiferings and financial resources, vast changes
would be made in the character of construction. The physical
fact of existing construction prevents a theoretical substitution
of what is the best construction for any conmiunity, tc^ther
with its costs for the construction which was actually made
years ago.
§ 80. Substitute plant—Discustion by C. L. Corey.
C. L. Ck)rey, in a paper on ^' Rates for Gas Service/' read
b^ore the nineteenth meeting of the Pacific Ck>ast Gas
Association, says:*
" ProoeediagB of American Sodety of Civil Engineeis, Januaiy, 1911,
p. lie.
* American Gaa Light Journal, October 23, 1911, p. 260.
Digitized by VjOOQ IC
1 81) CJosT ap Repb<m>uction 77
The oosfe of reproduction, new, has been variously interpreted,
sometimeB erroneously, especially when it has been held to
mean a system identical with the one the valuation of which
is under consideration. Properly, it should be understood
as a plant of similar character and equal efficiency. . . .
It will depend upon conditions as to whether the cost ctf
reproduction, new, and the original cost vary materially. One
of the principal dififerences which will be found will be in the
sixe and capacity and number of units in the two cases. Gas
plants are probably never built in a single year, nor used ex-
actly as they were originally constructed for a number of years.
The original cost will probably properly cover the plants as
installed with small units, while the cost of reproduction, new,
may be considered to cover only the cost of a smaller number
of mudi larger units having the same aggregate capacity. Es-
pecially would this difference arise in connection with the dis-
tribution ^stem, both mains and services. Originally one
angle main, on one side of the street, and of comparatively
small siie, may have been adequate to provide gas service in
that particular vicinity. Later on it becomes necessary to
lay an additional gas main many times larger than the orig-
inal; and, as is often the case, this later main is laid upon the
opposite side of the street, resulting in the cutting of all serv-
ices leading to property on the side of the street where the
new main is laid and the connection of those services into the
new main instead of the old. As viewed from present require-
ments, one gas main alone might be considered in obtaining
the cost of reproduction, new, while the actual cost would
necessarily be greater.
S 81. Cost under present or original conditions.
3. Cost of reproduction may mean: (a) the cost at present
prices of land, labor and materials of reproducing the ex-
isting plant under present or hypothetical conditions, or
(b) the cost at present prices of land, labor and naaterials of
reproducing the existing plant under the actual conditions
under which the existing plant was originally constructed.
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78 Valuation [§ 82
§ 82. Pr4S8ent or origiiial conditions—Discussion before Amer*
lean Society of Civil Engineersi- 1911.
These two conceptions of what is meant by the term
''cost of reproduction" were brought out in the discussion
before the American Society of Civil Engineers of the
paper on " The Going Value of Water-Works," by Leonard
Metcalf and John W, Alvord,*® The paper discussed
contemplates the use of the cost of reproduction method.
Halbert P. Gillette, in discussing the paper, contends
that actual cost rather than reproduction cost should
govern, saying (at page 382) :
Adopting, as the writer does, the first premise, namely,
that a public service corporation is entitled to a fair return on
its investment and for its managerial services, most of the per-
plexities confronting an appraiser vanish. It follows logically
that the appraiser must base his appraisal on the actual con-
ditions under which the property was built and operated. If
trees were cleared, then he must allow for the cost of clearing,
although not a tree may now be standing. If streets were graded,
then that grading must be estimated, though to-day the en-
tire city is as level as a floor. If quicksand was encountered
in laying a pipe-line, then the added cost of excavating it
must be allowed, even though subsequent works have drained
the line so that it no longer has a yard of quicksand. If money
was spent to educate the public to the use of the conmiodity
sold by the corporation, then that money is a development
expense which must be allowed, even though the expense
would not now be incurred by a new corporation of like char-
acter. If the corporation has built railway lines to develop a
country, and has not only spent money to get people to settle,
there, but has experienced deficits below a fair return on its
investment imtil the country has become sufficiently popu-
lated, then this development expense must be allowed. In
brief, the entire history of the public utility must come within
the appraiser's knowledge and consideration.
^ Published in the TraoBactioiiB of the Society, 1911, Vol. 73, pp. 326,
382,388.
Digitized by VjOOQ IC
§ 83] Cost op Reproduction 79
In reply, the authors, Messrs. Metcalf and Alvord, state
that Mr. Gillette has misinterpreted the reconstruction
cost method and that that method as applied by the courts
does not involve the determination of the reproduction
cost of an equally efficient plant, but the reproduction
cost of the existing plant reproduced under the conditions
existing at the time the property was actually constructed.
They say (at page 388) :
In this he is wholly wrong, if he is seeking to interpret the
actual views of the writers, for the Courts have clearly laid
down the rule that the existing property shall be valued, and
not an equally efficient plant. . . . Without going into detail,
it is perhaps sufficient to state that, in a recent joint valua-
tion by the authors, the very elements which Mr. Gillette
says should be included in valuation, and could not be in-
cluded imder the reproduction cost theory, were included by
the writers, as, for instance, the removal of heavy earth em-
bankments, the existence of which cannot be wholly traced
to-day; the removal of trees; and the removal of houses and
buildings. The writers conceive that the past history of the
works and of their construction is of the utmost importance
to the appraiser, if he would render fair judgment on the value
of the property.
§ 88. Present or original conditions— St Louis Public Service
Commission^ 1911.
The report of the St. Louis Public Service Commission
on Rates for Electric Light and Power, made on Feb-
ruary 17, 1911, states that, in determining cost of re-
production for rate purposes, the Commission has taken
into consideration the actual conditions under which
the property has been created. The Commission says: ^^
As presented by the Company, the theory of the Cost of
fiCTroduction New means that the value upon which it should
" At pp. 20, 21, 29.
Digitized by VjOOQ IC
80 Valuation [( 83
be permitted to earn a fair return should be the estimated
cost of reproducing at the present time, the property as it
now exists.
At first sight this may appear reasonable, provided the es*
timates are reasonable. In fact the theory is probably as good
as many of the various theories advanced for arriving at an es-
timate of Earning Value, but there are so many and various
elements and conditions to be considered in the valuation of a
large* public service property that a strict adherence to any
set theory is likely to produce results which are manifestly
imreasonable and unjust.
- Table VII sets forth the Company's estimate of the Earn-
ing Value of its property according to the theory of Cost of
Reproduction New. Some of the items entering into this
Table are based upon costs as produced under conditions ex-
isting in the actual construction of the present property, while
other items are based upon purely hypothetical conditions
•f reproduction.
The theory of this presentation of Earning Value is rejected
by the Conmiission on the ground that it disregards the actual
conditions under which the property was produced, and sets
up a purely hypothetical case which is not analogous to the
one imder consideration. . . .
The aim of the Commission in determining the Elaming
Value of the property of the Union Electric Light and Power
Company, has been to arrive at a fair and reasonable present
value of the property in the service of the public at the date
of this investigation.
The theory or rather method by which the Conmiission haa
arrived at its final figures differs essentially from the theory
of Cost of Reproduction New, as used by the Company, in
that the Commission has taken into consideration the actual
conditions under which the property has been created, while
the Company, as stated before, has assumed a hypothetical
set of conditions. The Conmiission believes its own method
to be much the better one for arriving at results calculated
to do justice to all parties concerned. In the major item of
value, viz: the construction cost, there can be no dispute aa
Digitized by VjOOQ IC
§ 84] Cost of Reproduction 81
to method, as a great part of the property has been recently
completed, and in the older parts, through lack of reUable
data for old costs, the Conmiission's en^eers have been com-
pelled to a great extent, to use present prices. In fact it has
been agreed between the Commission and the Company that
the cost prices used are applicable to either theory.
In assigning costs or values to elements other than construc-
tion or those dependent directly on construction, the Commis-
sion has endeavored to arrive at figures which will represent
fairly what those costs should have been under all the existing
conditions.
§ M. Present or original conditions— Conclusion.
The treatment of pavement over mains laid at the ex^
pense of the city," of piecemeal construction," of over-
head charges," and of various other elements of valuation
depends upon which of the above methods " are adopted.
Considered from all points of view the method of reproduc-
ing the existing plant under the actual physical and other
conditions under which it was actually constructed seems
fair to both parties. It is a rule that corresponds to the
actual equities of the parties while the other rule gives an
unfair advantage in some cases to the public and in other
cases to the company.
"See §169. *« See $240.
» See §362. »SeeS81.
e
Digitized by VjOOQ iC
CHAPTER V
Actual Cost as. a Standard of Value for Rate Purposes
§ 95. Actual cost defined.
96. Actual cost a natural standard.
97. Difficulties of determination.
98. Difficulties pointed out in Louisville Telephone Rate Case.
99. Difficulties overestimated.
100. Fluctuations in cost.
101. Extent to which cost changes offset each other.
102. Justice Brewer in Ames v. Union Pacific Railway, 1894.
103. California Supreme Court, 1897.
104. Pennsylvania state courts in Butler Company and Spring Brook
Company Water Cases.
105. West Virginia Supreme Court in Coal & Coke Railway Case, 1910.
106. Wisconsin Railroad Commission in Appleton Water Case, 1910.
107. New York Public Service Commission in Kings County Lighting
Case, 1911.
108. Interstate Commerce Commission in Western Rate Advance Case,
1911.
109. Connecticut Public Utilities Commission rejects actual cost in
favor of reproduction cost, 1912.
§ 96. Actual cost defined.
Strictly speaking, actual cost means cost of original
construction plus cost of additions and betterments.
It excludes all expenditures for renewals and replace-
ments including supersession due to obsolescence or in-
adequacy. It includes only construction, additions and
betterments that are a proper capital charge under ap-
proved accounting principles. This conception of actual
cost, however, is one that has in the past been very im-
perfectly comprehended. Correct accoimting principles
are of comparatively recent acceptance and application.
The references made by courts to actual cost or original
cost plus improvements show that in most cases they
have loosely interpreted the term to include many things
182]
Digitized by VjOOQ IC
§ 96] Actual Cost 83
that are not properly a part of the actual cost of the
present property. In certain decisions it is apparently
assumed that actual cost or original cost includes discount
on securities issued, exorbitant profits to promoters, cost
of replacing worn-out or superseded property, dividends
paid out of capital, money sxmk in xmsuccessful experi-
ments. That is, the term is considered as an equivalent
to book value inflated by financial manipulation or loose
accounting. Considered in this light, it is little wonder
that ''original cost'^ has been discredited as a standard
of valuation.
§ 96. Actual cost a natural standard.
Actual cost properly considered is the most natmral
and in many respects the fairest single basis for the de-
termination of fair value for rate purposes. A fundamental
principle of public service regulation is that as the public
service corporation devotes its property to a public use
it may consequently be required to render the service
at reasonable rates of charge. Rates of charge to be
reasonable may not be in excess of the fair value of the
service and may not be higher than necessary to produce
a fair return on the property devoted to a public use.
The measure of the property devoted to a public use is
undoubtedly in the first instance, at least, the money
that the company has actually and necessarily invested,
i. e.y the actual cost.
§ 97. Difficulties of determination.
Another obstacle to the acceptance of actual cost as a
standard of value, besides the inapt use of the term,
has been the difficulty or impossibiUty of accurate de-
termination. Records have been lost or destroyed. Per-
haps the company is not interested in producing records
in existence or the representatives of the pubUc do not
care to take the trouble to unravel the tangled skein
Digitized by VjOOQ IC
84 Valuation [§ 98
of company finances. An article on the ^'Valuation of
Railways/' in the Railroad Age Gazette of January 29,
1909, page 220, treats of the difficulties of getting at the
original cost of a railway as follows:
In any systematic e£Port at valuation, cost is a matter for
early consideration. If legitimate cost can be determined with
accuracy, it can usually be relied upon as establishing a fair
presumption of value. But here an intricate situation presents
itself, and in the ascertainment of railroad cost many serious
difficulties will be encountered. Some managers and accounting
officers profess, with a convincing show of reason, inability to
determine with any considerable degree of precision what their
properties have cost. A few of the roads have been in existence
for three-quarters of a century. In the earlier days there was no
accoimting organization worthy of the name. The science of
accounts was imdeveloped, the art was practiced with a laxity
that is now difficult to comprehend, and there was little more
than accidental uniformity of method. Such records as were
made have, in many instances, been lost or destroyed. Consol-
idations have taken place, reorganizations have been passed
through, and purchases have been made, under foreclosure or
otherwise, at a valuation either greater or less than original
cost. Capital assets acquired at one price have been replaced at
another and dififerent one. Operating cost and capital expend-
iture have been hopelessly confused. Finally, funds available
for distribution have been withheld from shareholders and de-
voted to increase of capital investment and the improvement
of facilities for transportation. To what extent these and other
similar things have occurred, and to what extent actual invest-
ment has been increased thereby, are questions it would not
always have been easy to answer at the time; now it is all but
impossible.
§98. Difficulties pointed out in Louisville Telephone Rate
Case.
In Cumberland Telephone and Telegraph Company
V. City of Louisville, 187 Fed. 637, decided April 25,
Digitized by VjOOQ IC
§ 99] Actual Ck)ST 85
1911, United States Circuit Court, a suit was brought
to enjoin the enforcement of a rate ordinance. District
Judge Evans, in granting the requested injunction, says
(at pages 642, 644):
Not because the cost of the plant was at all conclusive in its
bearing upon the questions involved, but, as already stated,
because it might be helpful, the court, in the order of reference,
directed an inquiry into the actual cost of the company's prop-
erty in this city. The lapse of many years, the multitude of
items making up the total, the wide diversity of present views as
to what «q)enditures should have been or should now be included
in the cost of construction, etc., the manner of keeping the com-
pany's accounts (though no dishonesty is attributable, inasmuch
as no motive is conceivable which at that time tempted to
deliberate wrong), and other considerations have so obscured
the question of cost of the plant as to greatly weaken the value
of this inquiry, laborious and painstaking as it appears to have
been. With all these difficulties to contend with, the master
has found that the total cost of the company's plant and prop-
erty in this city, including toll lines but excluding real es-
tate, was $1,506,531.21, while the company insists that it was
$1,864,583.10— a difference of $358,051.89. ...
Consideration of these contentions between the parties in
connection with the master's findings, the exceptions thereto,
and the large mass of testimony directed to the subject of cost
of plant, will demonstrate the extreme difficulty of reaching a
satisfactory conclusion upon the subject upon any very reli-
able theory, and the fact becomes apparent that its cost, imder
the complications presented in the record, would furnish a fal-
lacious test of the actual present value of the company's plant
and property in this city where it is being used for the public.
We incline to think that these considerations may properly
relieve us of the necessity of passing directly upon the exceptions
to the findings as to the *' cost " of the plant.
§ 99« Difficulties overestimated.
In several cases the Wisconsin Railroad Conunission
Digitized by VjOOQ IC
86 Valuation [§ 99
has gone carefully into the question of original-cost-
plus-improvements and such cost as found has been
considered of great importance in fixing fair value for
rate purposes. In most of the state railroad appraisals
little attempt was made to secure the original cost.
In the Washmgton railroad appraisal, however, the
question of original cost was gone into most thoroughly
and it is stated that of the entire railway costs in Wash-
ington, the original cost was obtained for all but 5 per
cent.^ Mr, Gillette, the Consulting Engineer of the
Washington Railroad Commission appraised the original-
cost-plus-improvements of the Northern Pacific Railway
at $75,457,893 and the cost-of-reproduction-new at $103,-
613,442. The difference between original cost and cost
of reproduction is mainly due to the increase in the value
of the land owned by the company and especially the
terminal lands in Seattle, Tacoma and Spokane.
It seems probable that the difficulties in the way of
determining actual cost have been largely overestimated.
Certain important elements of actual cost can usually
be obtained. The actual cost of land can usually be
determined, and if not, its probable cost at the time it was
purchased can be estimated. Land is often a very large
factor in the valuation and usually shows the greatest
percentage of variation between actual cost and repro-
duction cost. If the date of construction and a general
description of the same are known, actual cost can be
estimated from records of prices of labor and materials
current at the time. Or cost of reproduction may be
estimated and such cost increased or decreased by a
percentage deemed just in view of the increase or decrease
in prices since construction. Such cost of reproduction,
however, should not be the cost of reproduction imder
^ Second and Third Annual Report, Washington Raikoad Commiasiony
1907-1908, p. 127.
Digitized by VjOOQ IC
§ 100] Actual Cost 87
present or hypothetical conditions but as near as may be
the cost at present prices of labor and materials of the
actual property used and useful for the convenience of
the public, reproduced as nearly as may be under the
actual conditions under which it was originally produced.
It must be borne in mind that cost of reproduction
is here used merely as an aid to the determination of
actual cost. We do not care to know the cost of a dupli-
cate or equally efficient plant under present conditions.
But, using present or average prices of labor and materials,
we attempt to reconstruct the existing plant under the
actual conditions as to street and other physical condi-
tions and as to development expense, contingencies,
interest and other overhead charges, under which the
existing plant was actually constructed. (See §§ 81-84.)
§ 100. Fluctuations in cost.
When a plant is first established, actual cost and cost
of reproduction are the same. Reasonable rates of charge
would consequently be the same regardless of whether
fair value were based on actual cost or on cost of repro-
duction. Let us assume now that the original capital
investment or actual cost remains the same for ten years
but that in that period the cost of reproduction is con-
stantly changing. As a first case, assume that prices of
materials during the 10-year-period decline 60% and that
labor declines 30%. Cost of reproduction has there-
fore largely decreased, and, on this basis, rates of charge
may be radically lowered. But this is not giving the
corporation a ^'square deal." It devoted a certain
amoimt of money to a public use and is equitably as much
entitled to a fair return on that investment provided
the business can be made to earn it, as though it had
actually loaned that amount of money to the public.
On the other hand, cost of reproduction ii]J3tead of de-
Digitized by VjOOQ iC
88 Valuation [§ 101
creasing without the fault or help of the corporation
may increase in the same way. Assume that during the
10-year-period the price of materials increases 60%, of
labor 30%, and of land 80%. Cost of reproduction
has now enormously increased and on this basis rates of
charge must be greatly increased. But this is just as
unfair to the consumer as the former case was to the
corporation. The consumer is compelled to pay a fair
return on a much larger sum than the corporation has
''expended in his service. Fimdamentally, therefore, is not
actual cost rather than reproduction cost the more equita-
ble basis for determining the rights and obligations of the
pubUc service corporation? The equity of the corporation
,is the capital actually devoted to a public use and the
equity of the public or the consumer is the right to the
service at such rates as may be reasonable and not higher
than required for a fair return on capital actually expended.
§ 101. Extent to which cost changes offset each other.
So far as changes in cost of labor and materials are
concerned, in the long run changes are likely to offset
each other. The corporation will gain if prices advance
and lose if they fall. Its chance for gain may be assumed
to ofifset its risk of loss. About 1896, prices reached a
low level and many properties could then be reproduced
for much less than original cost. Since then there has
been a general rise in prices. Structures built about 1896
cost, in many cases, much less than their present cost of
reproduction. But while changes in price levels tend to
offset each other and are consequently not one^ded in
their benefits and disadvantages, it is different with
certain other elements of reproduction cost. Land used
by public utilities seldom declines but often increases
enormously in value. There may be periods when the
land is stationary or even declining, but the movement
Digitized by VjOOQ IC
§ 1021 Actual Cost 89
during long periods almost invariably shows a marked
advance. Here, therefore, the advantage of the repro-
duction cost method is very one-sided. It is of very great
advantage in some cases from the standpoint of the com-
pany but correspondingly disadvantageous and unjust
from the standpoint of the public. If this disadvantage
were offset by a corresponding general decline in the
reproduction cost of some other equally important ele-
ment it would not be such a serious matter from an
equitable standpoint. But no such offset exists. An-
other element of reproduction cost where the variation
is all to the advantage of the company is the cost of
laying mains and the location of other services in the
streets. The streets, especially of the larger cities, are
constantly becoming more and more crowded with sewers,
gas and water pipes, conduits, wires, subways and serv-
ices of every conceivable kind. This complicated net-
work of pipes and wires makes the placing of new services
or the reconstruction of existing services more and more
difficult and costly. This condition gives the company
imder some conceptions of the reproduction method an
unearned increment.^ The actual cost method produces
a much fairer result.
§ 102. Justice Brewer in Ames v. Union Pacific Railwaji 1894.
In Ames v. Union Pacific Railway Company, 64 Fed.
165, decided November 12, 1894, Justice Brewer found
that the actual necessary cost of construction was greater
than the cost of reproduction and greater than the present
value but he held that nevertheless this "actual invest-
ment ... is not to be ignored, even though such sum
is far in excess of the present value.'' '
§ 103. California Supreme Courti 1897.
The case of San Diego Water Company v. City of San
<SeeS21. * See above, § 21.
Digitized by VjOOQ IC
90 Valuatiok (§ 103
Diego, 118 Cal. 556, 50 Pac. 633, decided October 9,
1897, involves a valuation for rate purposes. The lower
court held the municipal ordinance fixing water rates
unconstitutional, but was reversed by the Supreme Court
and the cause was remanded for a new trial. The de-
cision of the Supreme Court was rendered by a divided
court. Six of the seven judges concurred in the findings
but four separate or concurring opinions were rendered.
The opinion, written by Judge Van Fleet and concurred
in by two other members of the court, took strong ground
in favor of actual cost as the proper standard of value.
The following is from Judge Van Fleet's opinion (at
pages 636, 638 Pac.):
The second method is entirely inapplicable taproperty of this
kind. The construction of municipal waterworks is a matter
of growth. It is necessary in common prudence, on the one
hand, to construct the works of such capacity as to satisfy the
needs of the growing city, not only at the moment, but within
the near future; and, on the other hand, not to extend them so
much as to cast an unnecessary burden on the stockholders or
the present consumers. As such works are a necessity to the
city, they must keep pice with, and to some extent anticipate,
its growth. When constructed, they stimulate to that extent
the progress of the city, and tend, like all conveniences, to
lower the general cost of production of all things. It results that,
at least, the first water system in any city occupies the position
of a pioneer. At any expense the works must be constructed,
and usually no reward can be realized by the constructors until
some time has elapsed. In the meantime, as the city grows, in
part by reason of this very supply of water, the facility of con-
structing works of all kinds is increased, and the cost of such con-
struction diminished. It would therefore be highly unjust to
permit the consumers to avail themselves of the plea that, at the
present time, similar works could be constructed at a less cost, as
^ pretext for reducing the rates to be paid for the water. The
reduced expense, if it be reduced, is due, in part at least, to the
Digitized by VjOOQ IC
§ 103] Actual Cost 91
very fact that the city has been provided, at the cost of the
water company, with increased facilities for doing business.
But it is said that those who enter upon any business enterprise
undertake the risk of being undersold by those who, coining
later into the field, have the advantage of a cheapening of con-
struction. But this is not an ordinary business enterprise.
Those who engage in it put their property entirely into the
hands of the public. Having once embarked, it is beyond their
power to draw back. They must always be ready to supply
the public demand, and must take the risk of any falling off in
that demand. The}*^ cannot convert their property to any other
use, however unprofitable the public use may become. They
have expended their money for the benefit of others, and sub-
jected it to the control of others. That money has, in eflfect,
been taken by the public; and the public, while refusing to return
that money, cannot be heard to say that it no longer has need
for all of it. Nor would it, on the other hand, be just to the
consumers to require them to pay an enhanced price for the
water, on the ground that it would now cost more to construct
similar works. Such a contingency may well happen; but to
allow an increase of rates for such reason would be to allow the
water company to make a profit, not as a reward for its ex-
penditures and services, but for the fortuitous occurrence of a
rise in the price of materials or labor. The law does not intend
that this business shall be a speculation in which the water com-
pany or the consumers shall respectively win or lose upon the
casting of a die, or upon the equally unpredictable fluctuations of
the markets. For the money which the company has expended
for the public benefit, it is to receive a reasonable, and no
more than a reasonable, reward. It is to be paid according to
what it has done, and not accordii^ to what others might con-
ceivably do. In effect, the bargain between the company and
the public was made when the works were constructed; and
this matter is to be determined according to the state of things
at that time. ... As we have said, it is not the water or the
distributing works which the company may be said to own, and
the value of which is to be ascertained. They were acquired
and contributed for the use of the public. The pubUc may be
Digitized by VjOOQ IC
92 Valuation [§ 103
said to be the real owner, and the company only the agent of
the public to administer their use. What the company has
parted with — what the public has acquired — is the money
reasonably and properly expended by the company in acquiring
its property and constructing its works. The state has taken
the use of that money, and it is for that use that it must provide
just compensation. ... It should, of course, be said that it
does not follow that in every case the company will be entitled
to credit for all of its current expenditures, or to receive a
compensation based on the entire cost of its works. Reckless
and unnecessary expenditures, not legitimately incurred in the
actual collection and distribution of the water furnished, or
in the acquisition, construction, or preservation of so much of
the plant as is necessary for that purpose, cannot be allowed.
Nor can the investment on which the company is entitled to
base its compensation be held to include property not now
actually employed in collecting or distributing the water now
being supplied, however useful it may have been in the past or
may yet be in the future. It is the money reasonably and prop-
erly expended in each year in collecting and distributing the
water which constitutes the current expenses which may be
allowed; and it is the money reasonably and properly expended
in the acquisition and construction of the works actually
and properly in use for that purpose which constitutes the
investment on which the compensation is to be computed. . . .
In fact, the case appears to have been tried largely on a wron^
theory, the greater portion of the evidence consisting of the
testimony of expert witnesses as to the value of the property.
This is, at the best, an unsatisfactory way of determining the
question of actual cost (for which purpose only could it be
admissible), and should not be resorted to when better evidence
can be obtained. As against the company, at least, its books
furnish better evidence on this subject, and cannot be disre-
garded. These books certainly show the cost to have been less
than $750,000, though we are unable to determine the precise
amount properly shown by them; and the evidence clearly dis-
closes that portions of the plant included in that cost are not
now in use, if, indeed, they have not been totally abandoned.
Digitized by VjOOQ iC
§ 104] Actual Cost 93
WhUe three of the other four judges concurred with Judge
Van Fleet in the decision rendered, they dissented from
the proposition that actual cost should be the standard
of value.
§ 104. Pennsylvania state courts in Butler Company and
Spring Brook Company Water Cases.
In the case of Brjrmer v. Butler Water Company, 179
Pa. 231, 36 Atl. 249, decided January 4, 1897, which was
an action by consumers among other things to enjoin
the water company from charging certain water rates,
the Supreme Court of Pennsylvania considered the basis
of valuation for rate purposes. Judge Williams says (at
page 251 Atl.):
This leads us to the second question raised, viz. : By what rule
is the court to determine what is reasonable, and what is oppres-
sive? Ordinarily, that is a reasonable charge or system of
charges which yields a fair return upon the investment. Fixed
charges and the costs of maintenance and operation must first
be provided for. Then the interests of the owners of the prop-
erty 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 pelds 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 cost
of the water to the company includes a fair return to the persons
who furnished the capital for the construction of the plant, in
addition to an allowance annually of a sum sufficient to keep
the plant in good repair, and to pay any fixed charges and
operating expenses.
In Wilkeebarre v. Spring Brook Water Co., 4 Lack.
(Pa.) Lc«. News, 367, 380, Judge Edwards, conunenting
on the above decision m Brymer v. Butler Water Co., says:
Digitized by VjOOQ iC
04 Valuation [§ 105
It may be contended that the rule adopted by our Supreme
Court is somewhat arbitrary. But we know of no better one.
The primary basis of any calculator as to the value of a water
plant must be the money actually invested by the owners. If
the earnings of the company have been used to improve the
property it is counted as so much more cash invested. In a
case in another state the market value of the plant was sug-
gested as the proper basis of calculation. This is open to two
objections. The plant, for many reasons, may have depre-
ciated in value and the consumers of water may have decreased
in their number, thus working an injustice to the owners; or
the plant, owing to favorable natural conditions and the rapid
growth of the territory supplied, may have greatly enhanced in
value, thus increasing the rates beyond reason and equity.
Another rule would be to ascertain the cost of replacing the
whole plant at a given time and make that the basis of the com-
putation as to its value. This is open to the same objection as
the first rule suggested.
§ 106. West Virginia Supreme Court in Coal & Coke Railway
Case, 1910.
The case of Coal & Coke Railway Co. v. Conley, 67 W.
Va. 129, 67 S. E. 613, decided March 8, 1910, Supreme
Court of Appeals of West Virginia, involves the validity
of a two cent per mile passenger fare statute. The court
aflSrmed the decree of the lower court restraining the
enforcement of the statute. Judge Poffenbarger, m de-
livering the opinion of the court, says (at page 640) :
However, it seems to be generally held that, in the absence
of peculiar and extraordinary conditions, such as a more costly
plant than the public service of the conmiunity requires, or the
erection of a plant at an actual, though extravagant, cost, or the
purchase of one at an exorbitant or inflated price, the actual
amount of money invested is to be taken as the basis, and upon
this a return must be allowed equivalent to that which is ordi-
narily received in the locaUty in which the business is done, upon
Digitized by VjOOQ IC
§ 106] Actual Cost 05
capital invested in similar enterprises. In addition to this, con-
aderation must be given to the nature of the investment; a
higher rate being regarded as justified by the risk incident to a
hazardous investment.
§ 106. Wisconsin Railroad Commission in Appleton Water
Case, 1910.
The Wisconsin Railroad Commission, while holding
that there is no single standard of valuation, has con-
sidered actual cost wherever data was available and has
based the element of going value almost solely on an esti-
mate of the actual cost of establishing the business. In
City of Appleton v. Appleton Water Works Company, 5
W. R. C. R. 215, decided May 14, 1910, the Conamission
says (at page 219) :
In determining the fair value of the tangible property, the
total investment in the plant at the time of appraisement, the
original cost of construction and subsequent additions and
extensions, the cost of reproduction new, and the present
value of the same are the only satisfactory evidences which
can be adduced, bearing upon the question. These factors
form a fairly reliable basis for the deduction as to the fair
value of the physical property. However, in weighing these
various factors consideration must be given to all the facts
and circiunstances surrounding the same, and neither of the
factors mentioned is controlling or determinative in reachii^
a final conclusion, although some may have greater probative
effect under all the circumstances than others.
In this connection the service value of the plant cannot be
ignored, for ''each imit of the plant has a value because of
its co-ordination and articulation with other units, and thus
forming with such units a complete mechanism, capable of
performing useful service." In re Cashton Light & Power Co.,
3 W. R. C. R. 67, 78. Furthermore, having arrived at a fair
value of the tangible property, we have determined the value
of but one of the elements that enter into the computation of
Digitized by VjOOQ IC
96 Valuation [§ 107
the reasonable present value of the investment and its relative
importance and bearing upon the ultimate deduction.
For rate-making purposes the actual total investment in
the enterprise, subject to certain qualifications, seems to be
the basis for determining the reasonableness of the charges
that may be exacted of the public for the services rendered or
product furnished in certain jurisdictions. Of course, where
such information is not available, the reasonable value of the
investment would have to be ascertained by some method of
appraisement, and in such event the '' actual total investment"
doctrine would be inapplicable.
§ 107. New York Public Service Commission in Kings County
Lighting Case, 1911.
In Mayhew v. Kings County Lighting Company,
2 P. S. C. 1st D. (N. Y.) — decided October 20, 1911,
in which it was sought to bring about a reduction in the
company's gas rate and in which the Conunission made an
order reducing such rates, the New York Public Service
Commission for the First District refa:^ to the importance
of actual cost in a determination of fair value, particularly
in view of the express provisions of the state statute.
Conmoissioner Maltbie, writing the opinion of the Com-
mission, says:
The cost to reproduce the property as new, obtained by add-
ing the percentage allowances to net cost, as shown in Table II,
is $1,880,355, or, if the pipe connection not in use be added,
$1,902,777. It is believed that either figure is ample and per-
haps too large. The company has produced no vouchers,
bills or records to discredit the estimates of the Commission's
engineers or to support the estimates of its own witnesses,
who were repeatedly asked whether they had examined the
records of cost of the company to determine whether their
estimates had any direct relation to the amounts actually spent.
They did not produce actual expenditures to support their
estimates, and counsel to the company expressed to the Corn-
Digitized by VjOOQ IC
§ 108] Actual Cost 97
mission the opinion that actual cost of existing property had
nothing whatever to do with the amount to be considered as
the tair value of the property. In our opinion it has a vital
relation, and in view of the provision in the Public Service
Commissions Law upon this point, the Commission must give
it full weight and consideration. Section 72 of the law provides
that " In determining the price to be charged for gas or electric-
ity the Commission may consider all facts which in its judgment
have any bearing upon a proper determination of the ques-
tion although not set forth in the complaint and not within
the allegations contained therein, with due regard among other
things to a reasonable average return upon capital actually
expended and to the necessity of making reservations out of
income for surplus and contingencies." The Commission re-
gards as a serious omission the failure of the company to pro-
duce the records, although requested to do so. In the absence
of such records, the Commission does not feel warranted in
accepting estimates which appear to be unduly and unrea-
sonably large, and are not supported by the examination
and estimates of our own engineers.
§ 108» Interstate Commerce Commission in Western Rate
Advance Casei 1911.
The injustice in certain cases of basing fair value
solely on cost-of-reproduction is pointed out by the
Interstate Commerce Commission in Advances in Rates,
Western Case, 20 I. C. C. R. 307, decided February 22,
1911. After discussing the enormous appreciation in the
value of railroad land and tiie lack of an authoritative
determination as to what constitutes fair value, Commis-
sioner Lane, in his opinion in this case, says that "Perhaps
the nearest approximation to the fair standard is that of
bona fide investment — thfe sacrifice made by the owners
of the property — considering as a part of the investment
any shortage of return that there may be in the early years
of the enterprise." The following is from Commissioner:
Lane's opinion (at pages 337-347):
7
Digitized by VjOOQ IC
98 Valuation [§ 108
. . . When asked by the Government to explain why it has
increased its charges, its reply is that it has a right to do so
because it is not now receiving a fair return upon the value
of the property which it uses; value being estimated cost of
reproduction. This leads to a few questions: (1) What did
the Burlington road cost those who built it? (2) What is its
present value? (3) Whence came this value? (4) Is such in-
crease in value a basis for increase in rates?
The controller of the company has given us the answer to
the first question. He testified that the total investment in the
property from the sale of stocks and bonds was $258,000,000.
To the second question the company answers that its present
value is $530,000,000.
The difference between these two figures represents (1) in-
vestment in the property made out of earnings; (2) increased
value of right of way and terminals owned by the company.
This is the answer to the third question.
The position therefore taken by the Burlington is that it
has a right vested in it by law to add to its freight charges
such amounts as will yield at the present time a fair rate of
interest upon more than $270,000,000, which does not represent
either the proceeds from the sale of a share of stock or a dol-
lar of borrowed money, so long as the rate to the shipper is not
unreasonable. ...
In support of this proposition the leading case of Smyth
V. Ames, 167 U. S. 446, 18 Sup. Ct. 418, 42 L. ed. 819, de-
cided March 7, 1898 (see above, § 24), and other cases are
cited. The Conunissioner continues:
Notwithstanding these decisions, it remains for the Supreme
Court yet to decide that a public agency, such as a railroad
created by public authority, vested with governmental au-
thority, may continuously increase its rates in proportion to the
increase in its value, either (1) because of betterments which
it has made out of income, or (2) because of the growth of
the property in value due to the increase in value of the land
which the company owns.
Digitized by VjOOQ IC
S 1081 Actual Cost 99
If the position of the Burlington is sound and is a precise
expression of what our courts will hold to be the law, then as
we are told there is certainly the danger that we may never
expect railroad rates to be lower than they are at presents On
the contrary, there is the unwelcome promise made in this case
that they will continuously advance. In the face of such an
economic philosophy if stable and equitable rates are to be
maintained, the suggestion has been made that it would be
wise for the Government to protect its people by taking to
itself these properties at present value rather than await the
day, perhaps 30 or 50 years hence, when they will have mul-
tiplied in value ten or twenty fold. . . .
Any new money put into the property, whether derived
from the sale of securities or from surplus, which might have
been appropriated to dividends^ represents new value — an ad-
dition to the property — ^and on this addition the stockholders
interest.ed are entitled to a reasonable return if that can be
had for an additional service given, but it is not equitable that
because the directors of a corporation see fit to distribute to
the stockholders less than the amount which the company
earns and may be appropriated to dividends, the shippers
who made this large dividend and surplus possible shidl be
increasingly taxed in geometrical progression to make return
upon it. New improvements should bring new revenue. The
risk of the stockholders in investing their money in these im-
provements is the same risk that they took when they invested
their original funds in the original property. San Diego Land
A Town Co. V. National City, 74 Fed. Rep. 87 [decided May 4,
We now turn for a moment to consider the added value of
railroad property by reason of the increase in the value of the
lands held as terminals in cities and rights of way. Out of
the difference between the original investment of $258,000,000
and the estimated present value of $530,000,000 it has been
estimated that the increase in land values amounts to approxi-
mately $150,000,000. We may agree with the contention of
the Burlington that it is no concern of ours as to whether these
lands were obtained by private or public donation in whole or
Digitized by VjOOQ IC
100 Valuation (§ 108
in part, but a larger question of public concern is. involved — the
legaJ right of a carrier to continuously increase rates because of
the growth of the community which gives this added value to
the land over which the railroad runs. . . .
It is unquestionable that Kansas would not enjoy the pop-
ulation that she has or the prosperity that is hers without the
presence of the railroads, and those men of prophetic vision who
projected those roads and invested their capital therein are
not to be denied a share in the wealth which they have so largely
helped to create. But as these lands increase in value with
the growth of the communities which they serve should not
this larger share coming to the railroad arise out of the opera-^
tion <rf that property and the increase in its traffic rather than
by the imposition of a new burden of tolls upon those who use
their road? This question is not of paramount importance
in this case, but, it is urged, may become one of supreme mo-
ment if the carriers insist upon a right to increase rates in pro-
portion to increasing land values. In a very real sense these
added land values do not come to the railroad as a railroad,
but as an investor in land which has been dedicated to a public
use; and, being so dedicated, it may be strongly urged that the
increment added thereto from year to year by communal
growth should not necessitate an impo6iti<m of additional rate
burdens upon the public. . . .
Whatever the true economic or legal view may be as to the
right of a carrier to consider the increase in value of its land as a
part of the value upon which it is entitled to a reasonable return,
such increase in value does not of itself establish the right of a
carrier to increase rates upon a given service. Certainly if
the Supreme Court may decline to lay down the absolute rule
that "in every case failure to produce some profit to those who
have invested their money in the building of a road is conclu-
sive that the tarifif is unjust and unreasonable, Reagan v. Farm-
ers' Loan & Trust Co., 154 U. S. 412, it is a conservative state-
ment of the law to hold that a railroad may not increase the
rates upon a number of commodities solely because its real es-
tate has risen in value. . . .
The trend of the highest judicial opinion would indicate that
Digitized by VjOOQ IC
S 109] Actual Cost 101
we should accept neither the cost of reproduction, upon which
the Burlington's estimate of value is made, nor the capitali-
zation which the Santa F6 accepts as approximate value, nor
the prices of stocks and bonds in the market, nor yet the origi-
nal investment alone, as the test of present value for purposes
of rate regulation. Perhaps the nearest approximation to
the fair standard is that of bona fide investment — the sacri-
fice made by the owners of the property — considering as part
of the investment any shortage of return that there may be in
the early years of the enterprise. Upon this, taking the life
history of the road through a number of years, its promoters
are entitled to a reasonable return. This, however, manifestly
is limited; for a return should not be given upon wastefulness,
mismanagement, or poor judgment, and always there is present
the present the restriction that no more than a reasonable
rate shall be charged.
§ 109. Connecticut Public Utilities Commission rejects actual
cost in favor of refirodactton cost, 1912.
In re fare charged by the Connecticut Company
between Manchester and Hartford, decided March 7,
1912, the ponnecticut Public Utilities Comnusssion re-
jects the claim of the applicant that fair value for rate
purposes should be based on actual cost rather than on
cost-of-reproduction-less-depreciation. The actual cost
was estimated at $325,000 while the present cost-of-
reproduction-les&-depreciatian was fixed by the Com-
mission at $900,000. The Commission says:
We do not think that the original cost of construction, what-
ever that may have been, the price paid for the line by the
Connecticut Company, whether exorbitant or otherwise, or any
inflated value for the issue of stocks or bonds are proper stand-
ards to determine the value of the plant and equipment for
which the company is entitled to receive a fair income, but
that the cost of reproduction at the present time in this par-
ticular case is a more accurate standard and the one which the
Commission has followed in determining such value.
Digitized by VjOOQ IC
CHAPTER VI
Valuatioii of Land
1. Treatment of Appredatioa In Land Value
1 110. Trend of decisions and practioe.
111. Consolidated Gas Case — Decision of District Judge Hough.
112. Consolidated Gas Case — United States Supreme Court.
113. Wisconsin Railroad Commission.
114. Committee of National Association of Railway Commiasionen,
1910.
115. South Dakota Railroad Commission, 1910.
116. St. Louis Public Service Commission, 1911.
117. Minnesota Railroad Rate Case, 1911.
118. Interstate Commerce Conmiission — Problem discussed but not
decided.
119. Allowance of no return or a reduced rate of return on land.
120. Reduced return allowed on terminals — Minnesota Supreme Court,
1897.
121. Appreciation should be set off against depreciation.
122. Appreciation treated as income.
123. Appreciation treated as income for purposes of United States
corporation tax.
124. Income method considered.
125. Actual cost v. present value.
a. Cost of Reproduction of Railroad Right of Way
1 134. Reproduction cost same as present estimated condemnation cost.
135. Multiples used in various state appraisals.
136. Minnesota Appraisal and Rate Case.
137. South Dakota appraisal, 1910.
138. Justification of use of multiples.
139. New Yoric Appellate Division rejects use of multiples in tax case,
1911.
S. Cost of Reproduction of Terminal Land
f 140. State railroad i4>pnusa]8.
141. Minnesota Appraisal and Rate Case.
142. Minnesota Rate Case — Availability for rate purposes enhances
Value.
[102]
Digitized byCjOOQlC
§ no] Land— Appmciation 103
1 143. WiaooDsin Railroad CommisBion on availability for special use.
144. Value of adjacent land increased by presence of terminal.
145. Reproduction cost of land as affected by cost of hypothetical
buildings*
4. Methods of Appraising Land
i 146. Sales method defined.
147. Sales method discussed.
148. Sales method rejected in Minnesota Rate Case.
1. Treatment op Appreciation in Land Value
§ 110. Trend of decisions and practice.
In the valuisitions of railroads and other public utilities
that have been actually used as a basis for rate making
or public purchase, no case has been found in which land
has not been taken at its present value rather than at its
original cost to the company. This is true of the general
railroad appraisals for tax purposes in Michigan and Wis-
consin and the railway appraisals for rate purposes in
Minnesota and Washington, the valuation of street rail-
ways for purchase and rates in Chicago and Cleveland,
various valuations of waterworks for municipal purchase
or rate regulation and the valuations of the Wisconsin
llailroad Commission for rate regulation and public pur-
chase.
There are a few decisions that hold that fair value for
rate purposes should be based largely on actual cost (see
above, §§ 102-105) and imder this theory land will of coiu^se
be taken at original cost rather than present appreciated
value. The weight of authority, however, points strongly
to "present value" as the proper basis (see above, §72)
and "present value" has often been taken as practically
equivalent to cost-of-reproduction-less-depreciation. Un-
der the latter theory land would naturally be included
at its present market value unless good reason should
appear for different treatment. But the decided cases that
favor either actual cost or present value do not for the
Digitized by VjOOQ IC
104 ' Valuation [§111
most paxt discuss or consider the question in its bearing
on appreciation of land. That question has not come up
and been passed upon as a separate and distinctive ele-
ment in the valuation.
§ ill. Consolidated Gas Case— Decision of District Judge
Hough.
In the New York City 80 cent gas case^ the question
whether land should be included in a valuation for rate pur-
poses at cost or at present appreciated value was considered
at length. The testimony on behalf of the city indicated
that the land, the present value of which was $11,985,435,
originally cost about $3,539,000, thus showing an apprecia-
tion of $8,446,000. Taking the book value of the mains,
$7,852,151, and the book value of services, $1,212,071,
which amounts were considered a liberal estimate of the
cost of constructing the mains and the services, the value
allowed by the court for mains and services shows an
appreciation of $5,605,962. The appreciation of land,
mains and services therefore amounts to $14,051,962.
The briefs submitted by the city, the Attorney General
and the Public Service Commission contended that in case*
of lands, mains and services, the original cost rather than
the reproduction cost should be taken in the present case,
otherwise the company would be permitted to earn inter-
est and profits on an enormous amount of increased value
due not to the operations of the company but in the case
of the land to the natural growth of the city and in the
case of mains and services to the fact that the city at ita
own expense had built costly pavements over the mains
of the company and to the fact also that since the laying
of the mains the subsurface had become so crowded with
other subsurface structures as to increase the present cost
1 Consolidated Gas Co. v. City of New York, 157 Fed. 849, Decern-
ber 20, 1907.
Digitized by VjOOQ IC
§ 111] Land — ^Apprsciation 106
of laying mains. This contention was refuted in the
report of the master and in the opinion of Judge Hough
of United States Circuit Court. The arguments are best
stated by District Judge Hough (at pages 864-866) :
As to the realty, the values assigned are those of the time of
inquiry; not cost when the land was acquired for the purposes
of manufacture, and not the cost to the complainant of so
much as it acquired when organized in 1884, as a consolidation
of several other gas manufacturing corporations.
It is objected that such method of appraisement seeks to'
confer upon complainant the legal right of earning a fair return
upon land values which represent no original investment by it,
does not indicate land especially appropriate for the manu-
facture of gas, and increases apparent assets without increasing
earning power. Analogous questions arise as to plant, mains,
services and meters; the reported values whereof are the re-
productive cost less depreciation, and not original cost to the
complainant or its predecessors.
It appears by undisputed evidence that some of these last
items of property cost more than new articles of the same kind
would have cost at the time of inquiry; that some are of designs
not now favored by the scientific and manufacturing world, so
that no one now entering upon a similar business would con-
sider it wise to erect such machines or obtain such apparatus.
In every instance, however, the value assigned in the report is
what it would cost presently to reproduce each item of prop*
erty, in its present condition, and capable of giving service
neither better nor worse than it now does. As to all of the
items enumerated, therefore, from real estate to meters, in-
clusive, the complainant demands a fair return upon the re-
productive value thereof, which is the same thing as the present
value properly considered. To vary the statement: Complain-
ant's arrangements for manufacturing and distributing gas are
reported to be worth the amounts above tabulated if disposed
of (in conomercial parlance) ''as they are."
Upon authority, I consider this method of valuation correct.
What the court should ascertain is the "fair value of the prop-
Digitized by VjOOQ IC
106 Valuation [§ 111
erty being used " (Smyth v. Ames, 169 U. S., at page 546, 18
Sup. Ct., at page 434 [42 L. ed. 819]) ; the '"present" as compared
with ''original" cost; what complainant "employs for the
public convenience" (169 U. S., at page 547, 18 Sup. Ct., at
page 434 [42 L. ed. 819]); and it is also the "value of the prop-
erty at the time it is being used" (San Diego Liand Co. v.
National aty, 174 U. S., at page 757, 19 Sup. Ct., at page 811
[43 L. ed. 1154]). And see, also, Stanislaus Co. v. San Joaquin
Co., 192 U. S. 201, 24 Sup. Ct. 241, 48 L. ed, 406. It is impos-
sible to observe this continued use of the present tense in these
decisions of the highest court without feeling that the actual or
reproductive value at the time of inquiry is the first and most
important figure to be ascertained, and these views are amplified
by San Diego Land Co. t^. Jasper (C. C), 110 Fed., at page 714,
and Cotting v. Kansas Qty Stock Yards (C. C), 82 Fed., at
page 854, where the subject is more fully discussed. Upon
reason, it seems clear that in solving this equation the plus and
minus quantities should be equally considered, and appreciation
and depreciation treated alike. Nor can I conceive of a case to
which this procedure is more appropriate than the one at bar.
The complainant by itself and some of its constituent com-
panies has been continuously engaged in the gas business since
1823. A part of the land in question has been employed in that
business for more than two generations, during which time the
value of land upon Manhattan Island has increased even more
rapidly than its population. So likewise the construction ex-
pense not only of buildings, but of pipe systems under streets
now consisting of continuous sheets of asphalt over granite, has
enormously advanced.
The value of the investment of any manufacturer in plant,
factory, or goods, or all three, is what his possessions would sell
for upon a fair transfer from a willing vendor to a willing buyer,
and it can make no difference that such value is affected by the
efforts of himself or others, by whim or fashion, or (what is
really the same thing) by the advance of land values in the
opinion of the buying public. It is equally immaterial that such
value is affected by difficulties of reproduction. If it be true
that a pipe line imder the New York of 1907 is worth more than
Digitized by VjOOQ IC
§ 111] Land — ^Appreciation 107
was a pipe line under the city of 1827, then the owner thereof
owns that value, and that such advance arose wholly or partly
from difficulties of duplication created by the city itself is a
matter of no moment. Indeed, the causes of either appreciation
or depreciation are alike unimportant, if the fact of value be
conceded or proved; but that ultimate inquiry is oftentimes so
difficult that original cost and reasons for changes in value
become legitimate subjects of investigation, as checks upon ex-
pert estimates or bookkeeping inaccurate and perhaps inten-
tionally misleading. Cf. Ames v. Union Pacific R. R. (C. C),
64 Fed., at pages 178, 179. If 50 years ago, by the payment
of certain money, one acquired a factory and the land appurte-
nant thereto, and continues to-day his original business therein,
his investment is the factory and the land, not the money origi-
nally paid; and unless his business shows a return equivalent
to what land and building, or land alone, would give if devoted
to other purposes (having due regard to cost of change), that
man is engaged in a losing venture, and is not receiving a fair
return from his investment, i. e., the land and building. The
so-called "money value" of real or personal property is but a
conveniently short method of expressing present potential use-
fulness, and "investment" becomes meaningless if construed to
mean what the thing invested in cost generations ago. Property,
whether real or personal, is only valuable when useful. Its
usefulness commonly depends on the business purposes to which
it is or may be applied. Such business is a living thing, and
may flourish or wither, appreciate or depreciate; but, whatever
happens, its present usefulness, expressed in financial terms,
must be its value.
As applied to a private merchant or manufacturer, the fore-
going would seem elementary; but some difference is alleged to
exist where the manufacturer transacts his business only by
governmental license — ^whether called a franchise or by another
name. Such license, however, cannot change an economic law,
unless a different rule be prescribed by the terms of the license,
which is sometimes done. No such unusual condition exists here,
and, in the absence thereof, it is not to be inferred that any
American government intended, when granting a franchise, not
Digitized by VjOOQ IC
108 Valua-hom [1 112
only to reg[ulate the business transacted thereunder, and reason-
ably to limit the profits thereof, but to prevent the valuation of
purely private property in the ordinary economic manner, and
the property now under consideration is as much the private
property of this complainant as are the belongings of any
private citizen. Nor can it be inferred that such government
intended to deny the application of economic laws to valuation
of increments earned or unearned, while insisting upon the
usual results thereof in the case of equally unearned, and
possibly unmerited, depreciation.
I think the method of valuation applied by the report to land,
plant, mains, services, and meters lawful.
§ 112. Consolidated Gas Case— United States Supreme Court.
On appeal to the United States Supreme Court the
above position of District Judge Hou^ was approved.
Justice Peckham in delivering the opinion of the court
says: *
And we concur with the court below in holding that the
value of the property is to be determined as of the time when
the injury is made regarding the rates. If the property, which
legally enters into the consideration of the question of rates,
has increased in value since it was acquired, the company is
entitled to the benefit of such increase. This is, at any rate,
the general rule. We do not say there may not possibly be an
exception to it, where the property may have increased so enor-
mously in value as to render a rate permitting a reasonable
return upon such increased value imjust to the public. How
such facts should be treated is not a question now before us, as
this case does not present it. We refer to the matter only for
the purpose of stating that the decision herein does not prevent
an inquiry into the question when, if ever, it should be neces-
sarily presented.
§ 113. Wisconsin Railroad Commission.
The Wisconsin Railroad Conunission in its various val-
> Willcox 9. ConaoHdated Gaa Co., 212 U. S. 19, 52, 29 Sup. Ct. 192, 63
L. ed. 382, January 4, 1909.
Digitized by VjOOQ iC
( 114) Land — ^Apprbciation 109
uations for rate purposes has not questioned the justice of
allowing the appreciation in land values. In State Journal
Printing Co. v. Madison Gas & Electric Company, 4 W.
R, C. R. 501, decided March 8, 1910, the Conunission
says (at page 579) :
It is true that such elements of value among those which
have just been enumerated, as the natural increase in the value
of land and such increases in other property as may be caused
by rising prices of labor and material, may not be offset by
actual outlays on the part of the owners of such plants; that
to include such items in the valuation may, in a sense,
amount to a capitalization of unearned increments; and that
there may be some question as to whether this is equitable as
between company and consumers. There is much, however,
to be said on the other &dde of this question. That the law as
well as our social system recognizes such gains in practically
all other imdertakings, is evident from the fact that rents and
interest charges usually vary with the natural increase in the
value of the property they cover. As the cost of reproduction
of a plant usually plays perhaps the most important part in
determining its value, it is more than likely that the owners
would have to bear losses in case land and other property had
depreciated instead of appreciated. It would seem only just
that the rule should work both ways. ... In view of these
facts there would seem to be good ground, from both a legal and
economic viewpoint, for giving such appreciations in value
consideration in appraising public utilities. At any rate, we
can not now see good reasons upon which to exclude these ele-
ments from the appraisal of utility properties.
§ Hi. Committee of National Association of Railway Com-
missionerSi 1910.
John C. Lawrence, a member of the Washington Rail-
road Conunission, speaks of appreciation as follows, in
his report as chairman of the Committee on Railroad
Taxes and Flans for ascertaining the fair value of railroad
Digitized by VjOOQ IC
no Valuation [§ 116
property, to the twenty-second annual convention of the
National Association of Railway Commissioners, 1910
(Proceedings, page 141):
The increased value should be allowed in determining the
cost of reproduction, new, if the elements entering into the
cost of production have increased over original construction,
to exactly the same extent as would be done in lowering values
could the property be reproduced new at less than the original
cost. Variation between actual cost and cost of reproduction is
due to difference in unit cost of material and labor. It may be
true that there will be a difference in the quantities used in each
determination. In such cases the original quantities would likely
be greater, owing to line changes and invisible items of origi-
nal cost which would not be allowed in estimating reproduc-
tion. Not only is the railroad company entitled to the unearned
increment to the same extent as other property owners, but a
failure to allow for such increment would be an injustice to a
new competing line and would discourage competitive building.
This is illustrated where a new company, in a given locality, say
in a large city, would have to pay for necessary terminals
several million dollars more than an older line with a similar
amount of property, it being generally true to-day that the
cost of securing right of way and terminals has greatly in-
creased over former years. Other things being equal, in the
process of rate regulation and competition, the rates charged
by each being necessarily the same, if the older road were not
allowed the- increased value of its terminals to correspond with
the* new company, then its rates, based on the lower value,
would, by competition, govern the new road which would be
deprived of reasonable returns on the value of its property.
Such a policy of rate regulation would discourage competitive
railroad building, under such conditions, although the existing
line might not be able to properly care for the business offer-
ing.
§ 116. South Dakota Railroad Commission, 1910.
In commenting on the appraisal of the railroads of the
Digitized by VjOOQ iC
§ 116] Land — ^Appreciation 111
state made by its engineer, the South Dakota Board of
Railroad Commissioners says: '
While it may be true that much of the real estate upon which
lines of railway have been built in this state was donated to
the company, it is also true that the land so donated belongs
to the company regardless of the fact that it was donated, and
in fixing upon the value of this land it must be taken as df the
date of the appraisi(^. The railway company is entitled to
any increase in land values due to ordinary causes to the same
extent as it is in the price of rails, ties, or any other physical
item.
§ 116. St Louis Public Service Commissioni 1911.
In the valuation for rate purposes contained in a report
of the St. Louis Public Service Coinmission to the Munic-
ipal Assembly on rates for electric light and power, Feb-
ruary 17, 1911, the Commission included land at its
present value rather than at its cost to the company. The
original cost of the land was $414,240 and its present value
as estimated by the Commission was $800,000. The
company's valuation of the land was $3,449,220. The
Commission sajrs (Report, page 33) :
In determining the value of the land owned and used by
the Company and on which it is entitled to a fair return, it
seems necessary, in order to be consistent, to follow the same
rule as in the case of the other property of the Company,
that 19, to take its present value. And although this value
may be more than the original cost of the land, yet, inasmuch
as the land is used in serving the public, and if not so used
could be realized upon by the Company at its present value, it
seems only fair that this present value should be the basis for
estimating the amount of return which the Company is en-
* Report ai Gail C. Witt, Engineer to the Board of Railroad Ck>mmL»-
noners of the State of South Dakota, containing the report of the appraisal
of the railroad propertieB in the State with comments by the Board, dated
November 15, 1910 (in 2l8t Annual Report, 1910, p. 27).
Digitized by VjOOQ IC
112 Valuation [§ 117
titled to earn. If the real estate should have depreciated in
value since its purchase by the Company, it follows that a
return upon such depreciated value only would be allowed, as
is done in the case of the other physical property of the Com-
pany. This appreciated value is in the nature of a profit re-
invested for the use of the public^
§ 117. Minnesota Railroad Rate Case, 1911.
In Shepard v. Northern Pacific Railway Co., 184 Fed.
765, 806, decided April 8, 1911, Circuit Judge Sanborn
holds that:
The measure of the value of real estate is its market value
for its most available use. There was uncontradicted evidence
that the most available use of the terminal lands in Duluth,
the use for which they were of the greatest value, was their use
for railroad purposes, that they were indispensable for those
purposes, that the real estate dealers who testified to their
values had fixed them originally in 1906, without regard to
their value for railroad uses, and that since that time they had
advanced in value from 15 to 25 per cent. Thus the proof is
ample to sustain the addition to this 1906 estimate of the value
of these lands of 25 per cent, thereof for railroad value, cost of
acquisition, and consequential damages which the master al-
lowed.
§ 118. Interstate Commerce Commission— Problem discussed
but not decided.
The Interstate Commerce Commission in the case of
Spokane v. Northern Pacific Railway Company, 15 I. C.
C. R. 376, 414, decided February 9, 1909, considered
but did not decide the question as to whether the in-
creased value of railway right of way and terminals should
be included in the fair value for rate purposes. In this
case the Great Northern Railway Company estimated
the value of its right of way and terminals at $87,000,000
of which $55,000,000 was for terminals in ten cities. The
Digitized by VjOOQ IC
§ 118] Land — ^Appbbciation 113
Northern Pacific Railway Company estimated the value of
right of way and terminals at $107,000,000, $73,000,000
of which was for terminals in eight cities. The following
is from the opinion of the Commission:
The practical importance of this question will be readily
apprehended. The Northern Pacific Railway extends through
a comparatively thinly settled portion of this country. In
comparison with other sections land values along its line are
small. Its Unes penetrate no city which can fairly be called
a great city. Nevertheless, the cost of its right of way equals
almost one-third of the entire cost of reproducing that prop-
erty.
The original cost of this right of way to the Northern Pa-
cific Company was insignificant as compared with the present
valuation placed upon it. What of it was taken at the time
of the original construction, cost practically nothing. Much
of it was given by the Government for the purposes of a right
of way, which, it should be noted, is entirely distinct from
the land grant of the company. The terminals in Spokane
are mainly located upon the ri^t of way of the railway. They
cost the railway nothing whatever, and they are extended in
this statement at $7,000,000.
A considerable portion of its terminal property in Seattle
has been purchased within the last seven or eight years, but
the prices paid for this were nothing like the values now placed
upon it. It was said by one witness for the defendants that
the terminals of the Northern Pacific and Great Northern in,
Seattle had appreciated within the last few years 150 per cent.,
and that portions of their terminal lands had increased within
that time from 500 to 600 per cent.
Whatever may be true to-day, in the comparatively near
future the structures of the railways of this country will be
less in value than the land upon which they stand, estimated
as the value of the right of way has been estimated in these cases.
Whether, under the laws and Constitution of the United States,
our railroads can demand a return not only upon the money
which has beai actually invested in these properties, but also
8
Digitized by VjOOQ IC
114 Valuation [§ 119
upon this value, which has grown from almost nothing to vast
proportions without the expenditure of money or the assump-
tion of risk, is a question of tremendous importance.
Elaborate ^briefs have been submitted by counsel, at the
request of the Ck)nmiission, upon this question, but it does
not seem profitable to discuss or decide it in this connection.
We shall assume, in disposing of this case, that the cost of
reproduction is properly estimated upon the basis followed by
these defendants, and that the item of value of right of way is
to stand as a part of that cost, like any other item.
The same question is discussed at considerable length
by the Interstate Commerce Conmaission in Advance
in Rates, Western Case, 20 I. C. C. R. 307, 337-347, de-
cided February 22, 1911. Conunissioner Lane's opinion
is quoted at length above in § 108. The Commission holds
that an increase in land value should not justify an increase
in rates and apparently concludes that actual cost of land
is the more equitable basis of valuation though there may
be some doubt as to what will be determined to be the
true legal basis.
§ 119. Allowance of no return or a reduced rate of return on
land.
The theory has been advanced that in a valuation
for rate purposes, real estate may be considered separately
and allowed only such a return as together with the profit
from appreciation will constitute a fair return on the
investment in real estate. This theory is stated in the
brief of the City of New York before the special master
in the 80 cent gas case as follows:
The complainant is not only not entitled as against the
consumer to include in the investment on which a return is
to be based the appreciation on its real ^ate, the unearned
increment, but it may be seriously questioned whether it is
entitled to any return on its real estate investment at all.
Digitized by VjOOQ IC
§ 1201 Land — Apprsciation 115
One per cent., over and above the taxes, has beeti quoted as
reasonable for a real estate mvestment (the consumer is pay-
ing the taxes, as included in the operating expenses), and the
suggestion is made in the following case that capital can be
found to invest in real estate without return, except by ap-
preciation. (Canty, J., in Steenerson v. Great Northern Ry.
Co., 72 N. W. Rep. 713, at 718.)
The master in his report brushes this argument aside
with the statement that there is nothing in the proof
to support the contention that capital can be found to
invest in real estate without expecting a return therefrom
except through appreciation.^ This theory is not referred
to in the opinions of Judge Hough or of Justice Peckham.
Nevertheless it is conunon knowledge that the investor
in urban land does look to future appreciation as well as
to rents. He accepts a small nominal rate of return
in the shape of ciurent rents but supplements this in all
calculations as to the adequacy of his profits by his esti-
mate of the annual percentage appreciation in the value
of his holding. An adequate return in the land holdings
of public service corporations could justly be determined
in exactly the same way. If it is found that the annual
appreciation in land is 5% and that a fair rate of return
to the company on the fair value of its property is 7%,
then a net return of 2% plus this 5% appreciation is a fair
return on the present value of the land.
(120. Reduced return allowed on terminals— Minnesota
Supreme Court, 1897.
The case of Steenerson v. Great Northern Railway Com-
pany, 69 Minn. 353, 72 N. W. 713, decided October 20,
1897, involves the valuation of a railroad for rate purposes.
* ODDBolidated Gas Ck>. v, C^ty of New York, Circuit Ck>urt of United
States, Soothem District of New Yorlc, Report of Arthur H. Masten,
Master in Chancery ^ May 18, 1907.
Digitized by VjOOQ IC
116 Valuation R 120
In this case the cost of reproduction of raiht>ad land and
structures was made the basis of determining fair value.
The reproduction cost of the terminals in St. Paul and
Minneapolis amounted to about one-third of the total
reproduction cost of the railroad. Inasmuch as the re-
production cost of the terminal lands was determined
by the market value of neighboring lands, which value was
largely of a speculative character, the court determined
that a net retmix of 2^% on the terminal land consti-
tuted an adequate return for an investment of that char-
acter. Judge Canty, delivering the opinion of the court
di3cusses this question at length. His discussion is in part
as follows (at ps^ges 718, 719) :
7. (2) Let us now consider what in these times is a reason-
able income on $14,000,000, invested in these terminals, and
$30,000,000, invested in the rest of the road. The great value
of the real estate covered by these terminals is given to it by
anticipating the future. Very little of this real estate is In or
near to the business center of either city. Most of it is out-
lying city property and suburban property. It is safe to say
that o<^er real estate similarly situated, in the same portions
of St. Paul and Minneapolis, does not, on an average, yield
an income of 1 per cent, per annum above the taxes on the price
or valuation at which it is held; and there is, as a general rule,
no use to which such property can be put that will cause it to
yield any greater income. In fact, it is doubtful if the same
area of other property along and around these terminals
could, on an average, by any use to which it could be put, be
made to yield an annual income of 1 per cent, on one-third of
the valuation placed on these terminals. Again, it is safe to
say that in ordinary times, at least, capital could readily be
found to buy such property at its market value for the purpose
of renting it for 1 per cent, per annum above the taxes on it.
In fact, millions have often been invested in such property
without any prospect of any income at all from it for many
years, and imdoubtedly such will be the case again. Sndti
Digitized by VjOOQ IC
§ 120] Land — ^Appbbciation 117
real estate is valued, not on account of its present power to
produce an annual income, but because it is betieved that it will
be still more valuable in the future. The owner of such prop-
erty cannot expect to eat his loaf and still have it. He can-
not expect that the property will pay a fuUnBised annual divi-
dend, and at the same time double or treble in value every 10
or 20 years. He expects his dividends to accumulate in the
form of increase in value. Thus, according to the railroad
company's own showing in the present case, much the greater
portion of the terminals which it now values at $14,000,000,
were originally procured for the sum of $381,117. If this is
true, the company has already realized some tremendously
large dividends on these terminals. Again, if it and the owners
of other property similarly situated have anticipated the future
tdo much, and have set too high a value on their property, so
that, in the opinion of the public, there is no prospect of any
material increase in its value in the near future, that does
not prove that the {x-operty should produce greater annual
dividends. It simply proves that this property caimot be
sold on the market for what they pretend to value it at, and
that before sales can be made the price asked must be reduced,
so that there will be a prospect of future increase in value suf-
ficient to warrant investment, because the public, who fix the
market price, do not and cannot expect that the annual income
derived from such property will ordinarily be sufficient to
pay interest on the investment. The market price of such
property is not controlled, or, at most, is controlled only in
part, by its power to produce immediate annual income. Again,
the public, and not the court, must be the judge of whether
or not such property will increase in value in the future, and,
if so, how much. Whether the conditions warrant the opinion
ot the public in the matter is a question which the courts cfuv-
not go into, in such a case as this, any more than in many other
cases where public opinion establishes market prices. And,
where such property cannot be made to produce a reasonable
annual income on the present market price of the same, it is
clear that the public have anticipated a future increase in
such market price. It is no answer to this argument to say
Digitized by VjOOQ IC
118 Valuation [§ 120
that the raiboad company may not want to speculate, and is
entitled to more d^nite, and perhaps more substantial, returns
on its investment. It necessarily becomes a speculator when
it invests in such property. It has so invested, and profited
enormously by its speculations. The investments of a rail*
road company in this class of property are no more sacred in
the eyes of the law than the investments of private parties in
the same class of property. For the purpose of determining
what is a reasonable income to a railway company from its in-
vestments in this class pf property used for railroad purposes,
we have a right to consider what is a reasonable income to pri-
vate persons from their investments in the same class of prop-
erty when used for private purposes.
There is another consideration which, it seems to us, adds
most conclusive proof that our position here is correct. The
traffic on these railroad terminals will not bear any such exces-
sive and unreasonable charges as it would be necessary to make
in order to produce fuU-^ixed dividends on the enormous valua-
tion placed on the terminals. In this case the cost of reproduc-
ing the terminals is, as we have seen, one-third of the cost of
reproducing the whole railroad system within the State. . . .
Then, from all of these considerations, it is clear that where
real estate outside of the business center, and in the outlying
districts of a city, has been given a large speculative or pro-
spective value, it cannot, whether used for railroad terminals
or other purposes, be made, ordinarily, to produce a reason-
able annual income on the investment, and the profits which
are expected from such investments are not annual, but ac-
cumulated profits, to be realized by future increase in value.
Neither do these considerations deter railroad companies
from investing liberally in such property. They, as well as
other investors, have alwa3r8 been desirous of taking advantage
of any such expected increase in value, and it has been quite
common for companies having the means to acquire terminals
In a growing city far beyond their present needs. It is not nec-
essary to determine here what rate of annual income on the
cost of reproducing these terminals is the lowest which the court
would uphold before declaring the rates fixed by the commission
Digitized by VjOOQ iC
i 121] Land— AppftEcUTioK 1 19
confiscatory. But we are of the opinion that, exclusive of taxes^
2yi per cent, per annum is a liberal income on such cost, and
that is as far as it is necessary to go for the purposes of this case,
S 12L Appreciation should be set off against depredation.
In the brief of the City of New York before the special
master in the 80 cent gas case, the theory that appreciation
in land if allowed should be set off against depreciation
is set forth as follows (at pages 230, 231) :
That if the Court is going is allow the company apprecia-
tion on its land and the paving over its mains and services,
this should be set off against the claim of the company that
it should be allowed depreciation on renewals and repairs
equal to or greater than the 10.6 cents per thousand feet spent
for that purpose during the last twenty-one years, . . .
The above mentioned appreciation claimed by witnesses
for the complainants, of $10,531,781.66, is 6.4 cents per thou-
sand feet. Consequently, if the company is to be allowed by
the Court to capitalise its appreciation, which averaged 6.4
cents per thousand feet of sales during the last twenty-one
years, then its net depreciation which had to be made up by
repairs and renewals was not 10.6 cents, but only 4.2 cents.
Since there is every reason to believe that real estate will con-
tinue to grow in value as rapidly in the future as it has in the
past, the probable need of funds to meet depreciation in the
future will likewise be small, if the policy is to be sanctioned
by the Court of allowing the company to capitalize appreciar
tion.
The Consolidated Gas Company in its brief before the
Circuits Court states that, as to the suggestion that ap-
preciation should be offset against depreciation, this has
in effect been done since from the cost-of-reproduction-
new there has been deducted depreciation amounting
to over $600,000. This is of course a small sum in com-
parisoii with an appreciation of some $14,000,000 but it
is contended that ''if, through deterioration of localities
Digitized by VjOOQ IC
120 Valuation [§ 122
where complainant's land is located, such land had become
less valuable than its origmal cost, complainant would
have lost instead of gained in the balancing of apprecia-
tion and depreciation; and of course defendants would
have in^ted that this must be endured by complainant."
This argument does not, however, reach the contention
of the city that if there is to be an allowance in the ex-
pense account to cover future depreciation, that such
allowance should in justice be reduced by the amount
of existing or anticipated annual appreciation. This
contention was not discussed in any way in the opinion
of the special master or of the court. The court allowed
the company eleven cents on each thousand cubic feet of
gas sold to cover future depreciation.
§ 122. Appreciation treated as income.
Accepting the rule laid down by the United States
Supreme Court (above, § 112) that as a general rule land
should be included at its present or appreciated value,
the New York Public Service Commission for the First
District has adopted a method of treating appreciation
as income and thus neutralizing to a certain extent the
effect of appreciating land values in the determination
of a reasonable rate of charge. In re Gas and Electric
Rates of the Queens Borough Gas and Electric Company,
2 P. S. C. 1st D. (N. Y.) — , decided June 23, 1911,
Commissioner Maltbie discusses this problem as follows:
Land differs from most property in that it generally ap-
preciates in value, and the question has been raised, whether
land should be included in "fair value" in rate cases at its
original cost or at its estimated value at the time the rate is
to be fixed. It is well settled that other property should be
taken at its then value, but it has been argued that in the case
of land the original cost should be used. While it is evident,
therefore, that each case must be decided upon the facts peculiar
Digitized by VjOOQ IC
§ 122] Land — ^Appreciation 121
to it, the Commission believes it proper in this case to follow
the general rule, as stated by Judge Hough of the United
States Circuit Court (ConsoUdated Gas Co. v. City of New
York, 157 Fed. Rep. 855):
Upon reason, it seems clear that in solving this equation the
plus and minus quantities should be equally considered, and ap-
preciation and depreciation treated alike. Nor can I conceive of a
case to which this procedure is more appropriate than the one at
bar.
Thus, land has been taken at its fair value and not at its
original cost, and the annual appreciation of land has been
treated as a profit. By this method, all property is treated
absolutely alike, as Judge Hough suggests. No difference is
made, except that as depreciation represents a decrease in
assets, it is placed as a debit against operation, while apprecia-
tion is placed as credit because it is an increase in assets. Land
has sometimes been treated like other property only to a degree;
that is, each class has been appraised at its present worth or
value. That has been done in this case. But if property is
to be taken at its depreciated value where it has depreciated,
an entry must regularly be made in estimated operating ex-
penses equal to the average annual depreciation. Conversely,
if land, or any other property which genuinely appreciates
in value, is to be taken at its appreciated value, then an entry
must be made in the estimated receipts equal to the average
annual appreciation. Unless this is done, it is obvious that
the consumer will be bmrdened with all the estimated decreases
in assets but not credited with the increases in assets. If the
principle laid do¥m by the courts is to be follow^ in part, it
should be followed in whole.
It is suggested that the annual increase in the value of land
which is treated as income is not actually received. Increase
in the value of imoccupied land is not realized until sold or
put into use, but it is real, nevertheless, although payment
may be deferred. Likewise, payments to the depreciation
fund are not actually expended; yet they have be^en considered
Intimate charges in practically eyery case. Furthermore,
Digitized by VjOOQ IC
122 Valuatiqn [§ 122
the annual increment is no more indefinite than the total in-
crement— the present value. But if the present value can be
determined, it is possible to determine past annual appreciar
tion with positive accuracy, for it is only a simple mathematical
calculation. It is also probably as easy to estimate increases
in the near future as it is to estimate what obsolescence, which
is a form of depreciation, there will be in the future.
Indeed, the problem of handling appreciation is much sim-
pler than depreciation. If the property is growing more val-
uable, the investor need not worry; and if the state recog-
nizes his right to earn a fair return upon the increase, he is
fully protected. It is not necessary that the increase be repre-
sented by stocks or bonds, for if the earning power is there,
he will receive a return thereon, regardless of the amount of
securities. In fact, the existence of an increase which is not
represented by securities is an element of safety, a reserve fund
of a valuable kind.
There is a further similarity. The exact amount of de-
preciation and the annual rate are not definitely known un-
til the piece of property is actually replaced or has become
useless. The total appreciation and the average annual rate
are not known until the land is sold, but when it has been dis-
posed of (and plants are continually being removed and the
land sold), they become absolute certainties. Why should
these matters be considered less definite when applied to land
than when applied to the buildings thereon? The depreciation
of the buildings is a charge against operation; why should
not the appreciation of land be a credit?
The entries in the preceding tables representing the increase
in land have been carefully computed. It has been possible
to ascertain the approximate cost of the land and the date of
purchase. Having these facts, one may easily compute the aver-
age annual rate of increase. The experts called by the com-
pany and the Commission were also examined upon the present
trend of prices. The estimated increases used in the above
computations are believed to be conservative.
Analyses have been made to determine the effect upon rates
if the estimates of the real estate experts for the company
Digitized by VjOOQ IC
§ ^23] Land — ^Appbeciation 123
were to be used throu^^out, and it has been found that the
gas rate would be lowered n few cents and the electric rate a
few tenths of a cent.
Again in Mayhew t^* Kings County Lighting Co., 2 P.
S. C. Ist D. (N. Y.) — , decided October 20, 1911, Com-
niissioner Maitbie says:
In determining the fair value of the property, the Com-
mission followed the method of taking oU property in use —
limd as well as plant — at its present value. Depreciable prop-
erty was depreciated, and appreciable property (land was the
only instance) was appreciated, that is, the present value of
each class was taken. . . . This process was followed for every
year considered and, in the case of future years, it involved an
estimate of the amount of depreciation and of appreciation from
year to year. The former was deducted from the fair value upon
December 31, 1910, and the latter was added. In determining
operating expenses year by year, an allowance to meet such de-
preciation was included as a charge against income, for rates
should be such that the consumption of capital may be offset
by deductions from income. If these processes are correct, it
follows that appreciation should be placed as a credit to the
estimated income. It is indisputable that if depreciation is a
debit, appreciation is a credit.
§ 123. Appreciation treated as income for purposes of United
States corporation tax.
The United States Conunissioner of Internal Revenue
under date of December 15, 1911, issued a synopsis of
decisioins relating to the special excise tax on corporations.*
These rules provide that profits realized on the sale of
real estate and also appreciation in the value of unsold
property if taken up on the books shall be included in
the income of the corporation subject to a special excise
•See Treamuy Decioons, December 21, 1911, Vol. 21, No. 25,
pp. 67-6a.
Digitized by VjOOQ iC
124 Valuation [§ 124
tax. The foUowing are abstraeis from the C<»xun]ssion-
er's synopsis of decisions:
43. Profits realized on sale of real estate during the year,
also increase in value of unsold property, if taken up on the
books of the corporation, to be mcluded in income.
62. In the case of lands bought prior to January 1, 1909,
and sold during any subsequent year, the profits arising from
such sale, if no accounting of increased value of land was made
in returns for previous years, should be prorated in accordance
with the number of years the land was held by the corpora-
tion and the number of years the law was in effect.
86. Where increase or decrease during the year in the value
of real estate acquired in previous years, sold or held for sale,
is taken up on the books and the rate cannot be accurately de-
termined with respect to individual years, such increase or
decrease may be prorated as provided by regulations in cases
of sale of capital assets.
96. In case of corporations whose business consists in part
or wholly of mining, producing, and disposing of deposits of
nature (ores, coals, gas, petroleum, and sundry minerals) the
conduct of such business will be understood to comprehend
two classes of gains or losses, vis. :
(a) The gain or loss resulting from the sale of capital assets,
i. e., either the increment, or the loss, arising through pos-
sessing over a period of time the investment in the same.
(b) The trading or commercial gain attached to the con-
duct of the industry, the employment of working capital, the
effort and risk involved.
§ 124. Income method considered.
The reproduction cost of structures and equipment
fluctuates with changes in prices of labor and materials.
The movement, however, is not one-sided. It is as
likely to favor the consumer as the company. Experienee
has shown, however, that the general trend in city land
values is toward appreciation. Under the reproduction
Digitized by VjOOQ IC
i 126] Land — ^Appreciation 125
theory the movement ib therefore entirely one-sided. It
is always to the advantage of the company. If the re-
lations between the consiimer and the company are to be
based on equity it would seem that, accepting the re-
production method in valuations for rate purposes,
some exception should be made in the case of land. The
company is entitled to a reas(Miable return on the property
it devotes to a public use: but it is not equitably entitled
to a reasonable return plus an additional return brought
about by the appreciatian of land. Such appreciation
is cleaily a part of the i^tmn that the company is receiving
on its property. In treating the annual appreciation
as so much income and permitting the company to earn
a fair return on the present appreciated value of its
property, the New Yoric Public Service Commission
has adopted a just and logical method.
il25« Actual cost T. present Tftlue.
The treatment oi appreciation as income in a rate
case is a necessary adjustment of the reproduction method
to make it conform to fimdamental principles of equity.
Substantially the same result would be obtained but
more directly and logically by making an exception
of land and taking original cost instead of present value.
As noted above (§§ 81-84) there is good authority for the
rule that in applying the reproduction method, cost of
r^roduction shall be based on actual conditions under
which the present plant was produced and not on present
conditions. Carry this reasonable process a step further
and the actual conditions can be assumed to include the
actual conditions as to cost of land. Conceived in this
way the reproduction meUiod would still be true to at
least one of the theories on which it is based and because
of which it has received much of its authoritative support.
The reproduction method receives much of its support
Digitized by VjOOQ IC
126 Valuation [§ 134
from the fact that it is difficult or impossible to determine
actual cost owing to the complications arising from im-
provements, reconstruction, and supersession and the
absence or imreliabiUty of construction accounts. There-
fore the only satisfactory substitute is an estimate of
replacement cost. But these difficulties do not arise in
connection with land values. It is not necessary, while
adopting the reconstruction method for the determination
of structural value, to apply it also to land in spite of
the injustice to the consumer thereby produced. If,
however, as is often the case, the theory of reproduction
cost is based squarely on the investment that would
be required at the present time to provide a given serv-
ice, and this in absolute disregard of past investments,
vested interests and equities of every kind, then of course
land must be taken at its present value. (See above, §§ TO-
TS, 96.) But if this theory is adopted it will still be just
to include the probable income from land appreciation
with other income in estimating returns under proposed
rates.
2. Cost of Reproduction op Railroad Right of Way
§ 134. Reproduction cost same as present estimated con-
demnation cost.
Usually in the general state railroad appraisals the
value of land taken for right of way has not been limited
by the market value of adjacent land. An allowance
has been made for the hi^er price that the railroad
would have to pay on account of damages to land not
taken and on account of the fact that in condemning
land for railway purposes the railway company is usually
required to pay an amoimt in exceto of market value.
Certain instructions issued to appraisers by the Wis-
consin State Board of Assessment in its valuation of
Digitized by VjOOQ iC
§ 1351 Land — Railroad 127
railroads for tax purposes in 1903 contain the follow-
ing:*
The strip of land usually taken for railroad right of way is
not generally along or parallel to the boundaries of the land.
The proper construction of the road often makes access from
the land on one side to the land on the other side more difficult,
and such access at more than one crossing is often impossible
on accoimt of right of way fences, deep cuts, or high fills.
The natural drainage is oftentimes interfered with. Roads
and streets may be closed or changed. The noise, smoke,
danger, and inconvenience from the operation of railroads
may not be distinct subjects of damage, yet in so far as they
depreciate the market value of the remainder of the premises
they should be considered. These considerations always make
the right of way value more, oftentimes much more, than its
market value for other purposes.
To determine the value of the land in the present right of
way, such lands must be deemed as belonging to the owners
of the adjoining lands and to be acquired by negotiations with
such owners or under the power of eminent domain, whereby
the owners are entitled to just compensation for the land
actually taken and for depreciation in the market value of
the residue in consequence of the railroad crossing the part
taken. In ordinary language, the inquiry will be first, what
is the fair average market price per acre for ordinary pur-
poses of the land taken, and second, how much is the depre-
ciation in the saleable value of the residue of the parcel, lot, or
tract with the buildings thereon from which the right of way
is severed. The sum of the two items, first, the market price
of the land taken, and the second item, depreciation in the
saleable market value of the residue, will constitute the right
of way value.
i 188. Multiples used in Tarious state appraisals.
In the Michigan railroad appraisal, 1900, it was es-
* Report WisooDBiii Tax Commiasion, 1907, p. 274.
Digitized by VjOOQ IC
128 Valuation [§ 135
timated that railways would have to pay from two to
two and one-quarter times the market value of adjacent
property, and the estimated cost of reproducing the right
of way was fixed accordingly. A fixed charge of $3 to
$8.50 per acre was also added to cover expense of acquir-
ing abstracts, recording deeds, etc.
In the Wisconsin railroad appraisal the method used
has been described by Chief Engineer Taylor as fol-
lows:^
In farming lands, small towns, and suburban and residence
property, the right-of-way value was taken to be 250% of
the market value for other purposes.
In city property, the right-of-way value was taken to be
133% of the market value for other purposes, where the land
was owned in strips of 100 ft. width or leas, and 110% of the
market value for other purposes, where the land was owned in
blocks, or in widths greater than 100 ft.
This is still the general method followed in railroad land
appraisals made under authority of the Wisconsin Rail-
road and Tax Commissions.
The Washington Railroad Commission, in valuing the
Northern Pacific Railroad in 1908, states that in order
to reproduce the right of way^ it would be necessary to
pay prices ranging from the actual market value of the
land to 500% in excess thereof and that this fact was
considered by the Commission in fixing the reproduction
cost of railroad land.' In the Texas Railroad appraisals
very little allowance was made on account of added cost
for railway purposes, but Chief Engineer Thompson states
^ Discufision of paper by R. A. Thompson on ''Valuation of Railroad
Property/' published in Transactions American Society of Civil Engineers,
Vol. 52, p. 360 (1904).
* Finding of fact No. 33, in second and third annual reports, Railfoad
Commission of Washington, 1907-1908, p. 157*
Digitized by VjOOQ IC
§ 136] Lani>— Railboad 129
that a certain percentage was added to the actual market
value of land to cover damages to abutting pi^operty
owners.*
§ 136. Minnesota Appraisal and Rate Case.
Dwight C. Morgan, engineer in charge of the Minne-
sota railroad appraisal, holds that on an average the
Minnesota railroad companies are required to pay for
right of way three times the true value of lands taken.'®
He estimates the total true value of land for right of way
and station grounds, but excluding city terminals, at
18,374,125, and allowing for increased cost to the com-
pany he estimates the reproduction cost at $21,100,211.
The Minnesota Railroad and Warehouse Commission, to
whom Mr. Morgan submitted his report, disagreed with
Mr. Morgan in his contention that the reproduction
cost should necessarily be taken as the value of railway
land. The Commission would go no furtiier than to
admit that the company should be allowed the actual
cost to it of the land even though such actual cost was
in excess of the market value of adjaceitt land. A com-'
pany may have purchased its right of way when land
was very cheap or the right of way may even have been
granted by the government. The Commission argues
that it is certainly unjust not only to appraise the right
of way at a value based on. the present enormously in-
creased value of adjacent land but even to double or
treble such value on the theory that if the railroad were
now exercising the right of eminent domain it would
have to pay this increased price. The Commission says:
"It seems to us after a full consideration of this subject
* "Method Used by the Raiht>ad CommiBsioii of Texas in Valuing Rail-
road Properties," by R. A. Thompson, Transactions American Society of
OvU Engineers, Vol. 52, pp. 328, 361 (1904).
^ Annual report, Minnesota Raihoad and Warehouse Commission, 1908,
pp. 27-36.
9
Digitized by VjOOQ iC
130 Valuation (§ 136
that the tenn 'cost of reproduction' could never have
been used.by the courts in a sense which would permit an
entirely imaginary and artificial value to be placed upon a
property actually owned and in the possession of the
railway company." The Commission issued orders based
on the above valuations for the reduction of railroad
rates. The validity of these orders and of certain acts
of the legislature reducing rates was questioned in a
proceeding before the United States Circuit Court.
Judge Otis, Master in Chancery, in his report of Sep-
tember, 21, 1910, states that witnesses for both par-
ties usually used a multiple of three in appraising the
reproduction cost of railway right of way. Circuit
Judge Sanborn in approving the report of Judge Otis
says: "
But the evidence in this case is conclusive, nay, we may
say it is without ^conflict, that every railroad company is com-
pelled to pay more than the normal market value of prop-
erty in sales between private parties for the irregular tracts
it needs and acquires for rights of way, yards, and station
grounds. The defendants' witness, Mr. Morgan, testified
that in his opinion the companies necessarily paid three times
the normal value for the lands outside of the terminals in the
three cities and 75 per cent, more than the normal value for
their terminals within those cities. The master in effect found
that the cost of reproduction and the present value of the lands
for the terminals in the three great cities, including therein
all cost of acquisition, consequential damages, and value for
railroad use which he allowed, was only about 30 per cent, more
than the normal value of the lands in sales between private
parties. He found the value of the lands outside the terminals
to be only twice their normal value. Findings of lower values
would have been contrary to the great weight of the evidence
and without substantial support therein.
" Shepard v. Northern Pacific Railway Co., 184 Fed. 7^, 806, April 8,
1911.
Digitized by VjOOQ iC
§ 137] Land — Railroad 131
{ 137. South Dakota appraisali 1910.
Engineer Carl C. Witt in his report on the appraisal
of the railroads of South Dakota says: ^'
It is a well-known fact that the price paid for land to be used
for railway purposes on account of damage to the remainder
of the property is several times the farm value. After an in-
vestigation of the prices paid for right of way by the M. D.
& P. R. R. and the C, M. & St. P. Ry. for extensions in this
state in 1906 and 1907 and an investigation of the results ob-
tained by investigations made in Minnesota, Wisconsin and
other states by various taxing and appraising bodies and also
of the sale of public lands m this state and other states for
railway purposes, it was determined to use a multiple of 250%
throughout the state, both for property for station grounds
and right of way, the average outside of towns being some-
what highet and inside of towns somewhat lower.
This question of multiple value for railway property is one
that must be handled with great care, particularly in large
terminals, and requires a separate investigation for each case
to avoid vicious results. Fortunately there are no very large
terminals in this state and it is the belief that 250% is a fair
average multiple.
i 138. Justification of use of multiples.
In justification of including percentages or multiples
to cover all items entering into cost of reproduction
of right of way, Henry Earle Riggs in a paper before the
American Society of Civil Engineers, January 4, 1911,
says: "
" Report of Carl C. Witt, Engineer to the Board of Railroad Ck)inmi»-
sioDen of the State of South Dakota, containing the report of the appraisal
of the railroad properties in the State with comments by the Board, dated
November 15, 1910. (In Twenty-first annual report of the Board of
Railroad CommiaBionerB, 1910, p. 31.)
^* "Valuation of Public Service Corporation Property," by Henry Earle
RiggB, in Ptooeedings American Society of Civil Engineers, November,
1910, pp. 1369, 1428.
Digitized by VjOOQ IC
132 Valuation [§ 138
In building a new railroad, engineers prepare their esti-
mates of cost, including grading, rail and fastenings, ties,
bridges, and, among other items, right of way. Their clients
provide funds to build the line, and furnish, among other
items, cash for the right of way. The right-of-way account
in no wise differs from that of any other item of physical cost.
The right of way, with all its hold-ups, items for damages,
court costs, legal expenses, bills for personal services and ex-
penses in securing it, abstracts and recording of deeds, is just
as much an element of physical cost as the rails. The cost of
acquiring the right of way is as proper an element as charges for
inspecting the rails, freight charges on them, the loading and
unloading, or any other charges that enter into the cost of
rails delivered to the track-laying contractor.
R. A. Thompson in discussion of the above paper by
Mr. RiggSy criticises the use of large multiples as fol-
lows: **
The writer's experience as appraising engineer for more than
10 years with the Texas Railroad Commission, and for the
past 2 years as a construction engineer — having built about 160
miles of railroad in Oklahoma and Texas — confirms his belief
that, in the absence of actual figures of cost, right of way and
other railroad real estate should be appraised at but little
in excess of the market value of abutting property. The prac-
tice of the Texas Commission has been to add from 25 to 50
per cent. The conditions under which railroads were built in
Michigan, Wisconsin, Iowa, and Minnesota cannot have been
radically different from those in the Southern and Western
States. In Texas it has been a rare instance when a railroad
has had to purchase all of its right of way. Also, contiguous
lands have greatly increased in value since the advent of the rwl-
roads. It would appear highly illogical to advocate that these
increased values should be multiplied by 3 — or even IJ^ — and
used as a basis for taxing the railroads on the one hand, or tax-
i« Proceedings American Society of Civil Engineers, Januaiy, 1911,
p. 128.
Digitized by VjOOQ iC
§ 139] Land— Railroad 133
ins the puUie on the other, by permitting indebtednees to be
issued against it» the interest on which the latter must pay.
The ndkoad recently eonstructed by the writer traversed fer-
tile and thickly populated areas, already quite well served*
with transportation facilities. Only a small fraction of the necr
essary real estate was purchased by the railroad company, and
(Hily in a few cases of such purchase did it pay largely in excess
of the market value of the land — and these were where the road
interfered with houses and other farm improvements. In
cities and tovms, land was acquired at practically its fair
market value. For rural property, the ratios used by Pro-
fessor Taylor in the Wisconsin appraisal appear to be quite
fair, but in cities they are too high — especially for the South-
west. The Minnesota ratios appear to be unreasonably high.
§ 139. New Tork Appellate Division rejects use of multiples
in tax case, 1911.
People ex rel. New York, Ontario & Western Railway
Company v. Shaw, 143 App. Div. (N. Y.) 811, 128 N. Y.
Supp. 177, decided March 8, 1911, is a case involving the
assessment of railroad right of way in a New York tax
district. Reproduction cost was accepted as the measure
of value for the purposes of this case. In valuing the
land the court rejected the proposed allowance for ab-
stracts and condenmation proceedings and for a valuation
of the land at three times the value of adjacent lands.
Judge Kellogg in delivering the opinion of the court says
(at page 814) :
The court disallowed the $1,000 item for procuring abstracts
and for condemnation proceedings, etc, upon the ground that
it was speculative, and that there is no proof that condemna-
tion proceedings would be necessary. It does not appear from
how many owners the different parcels of land were taken,
and there is no real basis upon which this item may be com-
puted. . . . The decision of the court upon the merits is sat-
isfactory until we approach the item of $15,000 for land, which
Digitized by VjOOQ IC
134 Valuation [f 140
is conceded to be three times the actual value of the land it-
self. Experience indicates that probably land through an
agricultural country served by no railroad would be given
gratuitously or upon reasonable terms for a right of way for
a branch line like this. It is not fairly within probabilities
that tiie farmers whose lands are to be taken and who are to
be given the privileges of a railroad would expect additional
damages over and above the actual value of the land taken.
The evidence upon the subject is purely speculative. I think
the $10,000 over and above actual value is not part of the
reproduction cost, and its allowance is not sustained by the
evidence or the facts in the case. It should, therefore, be
disallowed^
3. Cost of Reproduction of Terminal Land
§ 140. State railroad appraisals.
In the Washington railroad appraisal the Commission
determined the present value of terminal land^ by hear-
ing the testimony of real estate experts as to their opinion
of present values and as to present cost of acquiring such
land for railway purposes. It has been stated that the
Washington Railroad Commission attempted to estimate
the cost of these lands if taken at present under condemna-
tion proceedings.
In the Michigan railroad appraisal of 1900, the ap-
praisal of railway land in Detroit, Grand Rapids, Sagi-
naw, Bay City and some other large cities was assigned
to special appraisers who examined the property and
conferred with real estate men and experts in values. ^^
In the Wisconsin and Minnesota railroad appraisal
the sales and assessment n^ethod was used in appraising
terminal land. In Wisconsin, terminal lands were usually
>*See Henry Earle Riggs, "Valuation of Public Service Corporation
Property," in Proceedings American Society of Civil Engineers, Novem-
ber, 1910, p. 1420.
Digitized by VjOOQ iC
$ 141] Land— TeAioKaL 135
appraised at 110 per cent of the market value of adjacent
lands as determined by this process (see § 136).
§141. Minnesota aiipraisal and rate case.
In Minnesota, Mr. Morgan, engineer in charge of the
Minnesota railroad valuations, estimated that on an
average, the Minnesota railroad companies have been
required to pay for railway terminals in large cities from
one and one-quarter to one and three-quarters times the
true value of the land for other purposes. He estimated
the value of terminal lands without the multiple for special
railway cost at $32,901,134 and with the multiple added
at $52,011,546. The Minnesota Raibroad and Warehouse
Commission to whom Mr. Morgan submitted his report,
declined to allow the use of these multiples in their valu-
ation of railway terminals.^* When the rates made by
the Minnesota Commission and by the Legislature came
before the courts the engineer testifying for the state
before the special master stated that his valuations of
terminal properties in St. Paul, Minneapolis and Duluth
were based on the sales and assessment method and that
to the valuation as thus found he added 75 per cent,
as he considered that railroad conipanies were on the
average required to pay 75 per cent in excess of the market
value for such properties. The valuations as testified
to by the engineer for the state were, however, much
lower than the valuations made by certain real estate
experts employed by the railroads. Their valuations were
based on value for railway purposes which was consider-
ably in excess of estimated value for business purposes.
Judge Otis, master in chancery, in his report of Septem-
ber 21, 1910, declined to give weight to the assessment
and sales method in determining terminal values. He
* See Annual Report, Minnesota Railroad and Warehouse Conmussion,
1906, p. 13.
Digitized by VjOOQ IC
136 Valuation [§142
accepted the appraisals made by the real estate experts
for terminals in St. Paul and Minneapolis, with an ad-
dition of 5 per cent to cover cost of acquisition and con-
sequential damages. As to Duluth, however, the master
considered that the appraisers had been too modest in
fixing their valuations and seemed to have adjusted them
with reference to the adaptability of the property for
general business enterprises and not to have taken into
consideration their special and increased value for rail-
road purposes. He accordingly increased their appraise-
ment by 25 per cent.
§ 142. Minnesota Rate Case — ^Availability for railroad pur-
poses enhances value.
Judge Otis, in his report of September 21, 1910, states
that the topography of the lands through which a railroad
is projected has much to do with their availabiUty for
railroad purposes and that such availability necessarily
and properly enhances their value for which the owner
is entitled to compensation. Consequently, lands thus
favorably situated for railway terminal purposes may
have much greater value than adjoining properties. He
says (Shepard v. Northern Pacific Railway Company, in
equity, Report of Charles E. Otis, special master in
chancery. United States Circuit Court, District of Minne-
sota, Third Division, September 21, 1910, §§ 69, 70):
While it is true that the highest value of these terminal
properties is their adaptability for railroad purposes and they
must be acquired in a continuous tract suitable and convenient
jbo meet the demands of the business and traveling public, thus
largely enhancing their value, yet it is not true that these values
for such purpose are limited only by the needs of the company
and upon the theory that it must have the property or abandon
the enterprise. It is not the needs of the company but the
peculiar fitness and adaptability of the property for r^ulroad
purposes which gives it an enhanced value — often very much
Digitized by VjOOQ IC
§ 143] I^ND— Terminal 137
greater than for any other purpose. The fact that there is
other property equally available in the immediate vicinity,
that a line of road of substantially the same efficiency and
answering a like purpose can be secured by changing its course
or the location of terminals may be properly taken into con-
sideration as bearing upon railroad value. While it is true
that in these cases these particular terminals and rights of way
are the subject of valuation, and no other, still such valuation
must not be based upon the assumption that the companies
must have them at any price and must pay anything the owner
sees fit to exact, but should* be determined and controlled,
as far as may be, by a survey of the whole situation, and com-
parisons, where they can be made, with other, properties which
are in like manner avidlable.
The right of eminent domain is given to the company for
the purpose of preventing the property owner from taking
advantage of the necessities of the company as to any particular
tract. While it is intended to secure to him its full and fair
value for any purpose for which it is best adapted — and to this
end an appeal is given to the courts from unrighteous awards —
we are not to lose sight of the fact that railroads must be con-
structed along continuous lines and that the topography of
the lands through which the lines are projected has much to
do with their availability for railroad purposes and that such
availability necessarily and properly enhances their value, for
which the owner is entitled to compensation, and so it comes
about that properties so available and favorably situated
for the purpose have a much greater value than other adjoin-
ing or adjacent properties not so conditioned.
The position taken by the special master was sustained
by Circuit Judge Sanborn in Shepard v. Northern Pacific
Railway Co., 184 Fed. 765, 806, decided April 8, 1911
(quoted above, § 137).
§ 143. mnsconsin Railroad Commission on availability for
special use.
That peculiar availability for the special purpose for
Digitized by VjOOQ IC
138 Valuation (§ 144
which it is iised gives added value for rate valuation pur-
poses to land owned by a public service corporation is
apparently denied by the Wisconsin Raihroad Commission
in a case involving a valuation of a gas and water plant
for rate purposes: "
The respondent has objected to the tentative valuation of
the land, claiming that its peculiarly favorable location for
the use to which it is put is an additional element of value.
The testimony shows that the only available water supply
of Ripon is obtained from an underground stream which is
tapped by respondent's wells. The ground in question, on
which such wells are located, is on the lowest point over such
undergroimd stream, or where the stream can be reached with
the least excavation, and that to tap the stream at any point
away from respondent's location would entail an additional
expenditure for excavation to the amount of from $3,000 to
$6,000 which, it is claimed, should be added to the present
value. . . . The stockholders and the public, in the case of
a public service corporation, are entitled to demand from the
management that degree of judgment and foresight which
is to be expected from men entrusted with the expenditure of
such large sums of money in investments of a permanent char-
acter. Expenditures incurred in making a wise selection or
an increased price because of favorable featiu*es are properly
chargeable to capital. It does not follow that the exercise of
such intelligence as is reasonably to be expected under the
circumstances should be capitalized. No facts have been pro-
duced which, in the light of the above discussion, should call
for an increase in the value of the land for the purpose of pass-
ing on the questions in issue.
§ 144. Value of adjacent land increased by presence of
terminal.
John Earl Baker, in the Journal of Accountancy for Au-
gust, 1909, argues against the method that has usually
" City of Ripon o. Ripon Light and Water Co., 6 W. R. C. R. 1, 12,
March 28, 1910.
Digitized by VjOOQ IC
§ 144] Land— Terminal 139
been employed in the valuation of railway terminal
lands. He contends that the reproduction value of ter-
minal land should not be based on the locations imme-
diately adjoining the terminal. Locations immediately
adjoining the terminal are much sought after for certain
uses and consequently the market price is apt to be much
higher than that of surrounding land which has not been
affected by the location of the terminal. Because the
adjoining locations are valued so highly, it does not follow
that the terminal land has asimilar value. In case of the
removal of the existing terminal and the sale of the
terminal site it would not bring the price at which ad-
jacent property is now selling and such adjacent prop-
erty would itself decline in value. He contends that the
value to be placed on the terminal land is the value that
the land would have if the terminal were not present.
Mr. Baker says (at pages 240-246) :
Locations adjoining a terminal are much sought after by
factories, wholesale houses, elevators, and warehouses, be-
cause such access saves drayage, expedites shipments, and
makes it possible to handle some heavy kinds of goods which
otherwise could not be bought or sold at all. . . . Because this
adjoining space is valued so highly, appraisers have considered
that the terminal spaces have a similar value. But this con-
clusion does not follow. Mark you, the competition is for the
space adjoining the terminal, not for the space which the ter-
minal occupies. Business houses do not want to supplant the
terminal. Not at all. They want it to stay right there. What
they want is simply to be neost to the terminal. Suppose the
terminal attempted to sell the whole area it occupies. It is
very clear that unless some other very potent influence were
brought to bear on the situation, no such prices could be ob-
tained for the whole or any part as are paid for the bordering
properties. . • • The value which should be allotted to ter-
minals is not what it would cost to buy up these feverishly com-
petitive fringing properties, but what the land would be worth
Digitized by VjOOQ IC
140 Valuation [§ 144
if the terminal and its satellites were not present. . . . What
the cost would be to a new company to build a terminal beside
the one to be valued, or to the present owner to make exten-
sions or enlargements, has nothing to do with the values of
lands which are owned now. In the first place an invading
company would never build a terminal alongside of the old
resident. It is far better business to build in a less expensive
section and wait for the business to come to it, which it always
does in time. ... If the old terminal does make the enlarge-
ment, of course its actual investment should be given full
weight.
The author goes on to state that in case during the history
of a terminal there have been several enlargements so
that the entire terminal if now valued on the basis of
other-use-with-the-raih'oad-absent would show less than
actual cost, that this condition should be recognized and
the valuation so fixed that it will at least represent the
actual cost of the terminal to the company. The author
concludes (at page 249) that unless his method of valuing
terminal land is adopted:
The only other avenue of escape from increasing rates is
for government to take the other horn of the dilemma and
deny the use of any value except that of the original cost — ^the
few hundred dollars instead of the many millions. Indeed this
procedure is seriously proposed. Using the argument of Alfred
Crozier in the Magnet some declare, "eminent domain is a
loan of governmental power . . . instead of a grant of prop-
erty. . . Any extra value or profit received by the corporation
as a lesult of exercising that borrowed power must belong to
the public — not to the corporation." Anything beyond a
fair interest rate upon the funds actually invested must there-
fore go to the public in the form of increased service or lower
rates. The "unearned increment" is not to be divided, but is
to go entirely to the public, for the railroad is discharging a
public function as the agent of government, and railroad share-
Digitized by VjOOQ IC
§ 145] Land — Terminal 141
holders are duly compensated by a fair return upon their in-
vestment.
It should be noted with reference to Mr. Baker's argu-
ment, that the influence of railway terminals is not
necessarily one of appreciation in the value of adjoining
property. In some cases adjoining property is seripusly
depreciated in value. A given terminal may appreciate
certain adjoining property and depreciate other adjoining
property. Residence property will usually be depreciated.
A similar question arises in the valuation of a gas plant
with reference to the present value of land occupied by
gas holders. Neighboring property is often depreciated
by the existence of a gas holder. This being so, should
the value of the land occupied by the holder be based on
the present value of adjacent land or on the increased
value that such land would have if the holder were not
there?
§ 146* Reproduction cost of land as affected by cost of hy-
pothetical buildings.
Re MetropoUtan Street Railway Reorganization, 3
P. S. C. 1st D. (N. Y.) 113, decided February 27, 1912,
is an application for the approval by the New York Public
Service Commission for the First District of an issue of
securities subsequent to reorganization. As to the value
of the land, the applicants submitted appraisals by their
experts as to the land alone, on the assiunption that there
were no buildings upon the property and that the land
was about on a level with the street, and separate "cost-
to-reproduce" valuations of the buildings in fact on the
property, on the assumption that the buildings were to
remain for many years, until their usefulness for street
railway purposes should cease. The appUcants contended
that the valuations should be based on the assumptions
(1) that the applicants' street railway system did not
Digitized by VjOOQ IC
142 Valuation I§ 145
exist but that the city were otherwise as it is to-day;
(2) that an imaginary company starting in under such
circumstances would seek to duplicate the system which
the applicants in fact have; (3) that it would want, for
car storage bams and similar purposes, the exact parcels
now owned by the applicants' system, even though the
parcels still used by the applicants' system for such
purposes are located in highly develop^ and valuable
areas; (4) that upon every such parcel the imaginary
carrier starting anew would find buildings similar to those
now surrounding the property; (5) that it would proceed
to tear them down and erect other buildings on the land,
the value of the land itself to be added to the reproduction
cost of the buildings torn down and the reproduction cost
of the buildiugs now in fact maintained on the land by the
applicants' system, to arrive at the fair present value
of the land and buildings. The applicants presented no
data showing that when the land was actually acquired,
buildings were in fact torn down. The Conmiission did
not accept this theory of land valuation. The Com-
mission says (at pages 139, 140) :
The theory is clear. The applicants assume that the Metro-
politan system does not exist, that otherwise the city is as it
is to-day, that an imaginary company starts in to duplicate
the existing system, that it would want the exact parcels now
owned by the Metropolitan system, that upon every parcel it
would find buildings similar to those now surrounding the
property, and that it would proceed to tear them down and
erect other buildings on the land.
There are several violent assumptions in this list, but one
illustration will suffice. The Metropolitan Ck)mpany owns a
whole block boimded by Fourth and Lexington Avenues, and
32d and 33d Streets. North and west of this block stand the
Seventy-first Regiment Armory, the new Vanderbilt Hotel
and the Park Avenue Hotel. South and east are apartments,
Digitized by VjOOQ IC
S 145] Land — ^Terminal 143
stores, warehouses, etc. Mr. Wheelock estimates the market
value, plus cost of acquisition, of the land in the block at
Sl,680,000, and at the request of counsel adds $340,000 to rep-
resent the cost of buildings like those just mentioned which
it is assumed would be razed to make way for a one-story car
bam; and coimsel asks that the Commission find the fair value
of the land in this one block to be practically $2,000,000,^ In
another instance, the imaginary buildings are said to in-
crease the "value" of the land by over 50 per cent, of what is
acknowledged to be its fair value as between a willing buyer
and a willing seller.
If this theory be sound, then when the block comes to be
entirely surroimded with buildings of fifteen or twenty stories
(that is the tendency in that district), the capitalizable value
of that land will be not only the fair market value of the land
itself, but that value plus the cost of these ten, fifteen or twenty-
story buildings,^ upon the assumption that "such buildings
would be cleared off." The company could then with equal
propriety appear before the Commission and ask that securities
be authorized for the difference between the estimated cost of
the surroimding buildings at present and the cost of the taller
buildings then existing.
The Commission does not accept any such theory as proper
or as affording the basis for determining the reasonable value
of the land, and no precedents or court decisions have been
cited to support it. It should be noted, also, that the ap-
plicants have not presented any data from the records of the
company to show that when the land was actually acquired
buildings were torn down. If a company were forced to make
such expenditures, they might be charged to capital subject,
perhaps, to amortization in part, but that is not the situation
at present. No such facts have been shown, and the question
is not what might be done to increase expense, but what is the
present reasonable and fair value of certain real property — ^not
including imaginary buildings.
li It should be noted that the imaginary improvements to be purchased
and thrown away are not valued at their scrap value but as commercial
enterprises.
Digitized by VjOOQ IC
144 Valuation [§ 146
4. Methods of Appraising Land
§ 146. Sales method defined.
In ordinary land appraisals the customary method has
been to secure the opinion of local real estate experts in
regard to the value of a particular piece of land. The
sales method or the sales and assessment method has been
used in certain public utility valuations. The sales method
was used partially in the Michigan Railroad Appraisal of
1900 and 1902. It was used in the Wisconsin Railroad
Appraisal of 1903 and in the Minnesota Railroad Ap-
praisal of 1907. The Wisconsin Railroad Commission has
made use of it in a number of public utility valuations.
It has been described as follows by W. D. Pence, Engineer
of the Wisconsin Railroad Commission: ^*
The sales method may be defined as a plan or process for
the systematic collection and comparison of data relating to
real estate transfers for the purpose of estimating true mar-
ket realty values. It consists in a study of the transfers of
neighboring property having conditions or characteristics
similar to the land whose value is to be determined, and is in-
tended to duplicate, as nearly as may be, the mental or judi-
cial processes ordinarily employed by the so-called "local real
estate expert," with a view to arriving at results approximat-
ing those which would be reached by such local expert acting
without bias or suggestion. The sales method is capable of
application in a variety of ways; in fact, is as flexible in its pos-
sible applications as are the varied methods employed by in-
dividual local experts. Two interpretations of the sales method
have been most commonly employed. In one of these the area
and consideration in each sale of similarly situated land is
found, and the average unit price (per square foot, per foot
frontage, per lot, per acre, etc.), ascertained, and this unit
applied to the tract under investigation. The other appli-
^ See State Journal Printing Co. v. Madison Gas and Electric Co., 4
W. R. C. R. 501, 628, March 8, 1910.
Digitized by VjOOQ IC
§ 147] Land — ^Appraisal Methods 145
cation of the method introduces what, in many cases, is be-
lieved to be an additional safeguard, consisting of the use of the
average assessed value of adjacent or similarly situated lands,
in combination with an average ratio or percentage repre-
senting the rdationship of the assessed value of transferred
lands to the total consideration paid for such transferred lands
in the district or locality under consideration, all of these figures
being based on the "groimd values" exclusive of the improve-
ments thereon. Such use of assessment figures is designed to
introduce, as far as may be, the results of the judicial proc-
esses of the assessor who, at least in theory, serves on behalf
of the public as an unbiased expert in the matter of relative
valuations, and who attempts to make allowance for the
peculiar attributes or characteristics of individual parcels
of real estate in any given locality or neighborhood of a city.
In the broader and more flexible applications of the sales
method, the expert adopts one or the other of the processes
just outlined, or blends the two together in such fashion as
to yield the most consistent and trustworthy final result.
§147. Sales method discussed.
The sales method is discussed by Dwight C. Morgan,
in his report to the Minnesota Kaihroad and Warehouse
CJonmiission, on the Minnesota Railroad Appraisal of
June 30, 1907.^ Mr. Morgan states that particulars and
detailed information as to the sales method may be found
in an address by T. A. PoUeys, Tax Conmaissioner of the
Chicago, St. Paul, Minneapolis and Omaha Railroad, and
in a paper by Prof. T. S. Adams, in the Proceedings of the
Minnesota Academy of Social Science, Vol. 1, 1907. The
sales method in relation to the Michigan Railroad Ap-
praisal is discussed at length in a paper by Henry Earle
Riggl3, Proceedings of American Society of Civil Engi-
neers, November, 1910, page 1369. The Wisconsin Rail-
road Commission discusses the sales method very fully in
* See Annual Report, Minnesota Railroad and War^ouse ComnuBsion,
1906, pages 29-36.
10
Digitized by VjOOQ IC
146 Valuation [§ 148
State Journal Printing Company t;. Madison Gas and
Electric Company, 4 W. R. C. R. 501, 535, decided
March 8, 1910, The Commission says in part:
It is, of course, a fact that the determination of the market
value of any piece of real property is ultimately a matter of
judgment, and that no method of valuation yet discovered
will disclose the exact value or do much more than indicate,
within perhaps fairly narrow limits, the figure at which the
value should be placed. But it is believed that the methods
thus employed by the staff are the best that have thus far been
used for this purpose. While in actual application they may
not disclose the actual figure at which the value should be fixed,
they can not fail to be of the greatest importance in appraisals
of this kind. When properly employed, they will disclose
facts that indicate approximate values, and facts that are of
the greatest aid to the judgment in arriving at the fair value
in each particular case.
§ 148. Sales method rejected in Minnesota Rate Case.
In the Minnesota Rate Case, Judge Charles E. Otis,
special master in chancery, in his report of September 21,
1910, declines to give much weight to appraisals made by
the sales method. In this case the valuations f oimd by the
state's witnesses using the sales and assessment method
were much lower than those testified to by the experts
employed by the railroads. The master in his report
says:^^
It is conceded that when applied to any particular tract of
land it cannot be relied upon, but it is claimed that when ap-
plied to extensive contiguous tracts, as are rights of way, the
doctrine of averages will bring about reasonably correct re-
sults. To make a market value assessment, the assessor could
*^ Shepard t;. Northern Pacific Railway C!o., in equity, Report of Charles
E. Otis, special master in chancery, United States Circuit Court, District
of Minnesota, Third Diviaon, September 21, 1910, § 73.
Digitized by VjOOQ iC
§ 148] Land — ^Appraisal Methods 147
not rely on such methods with respect to any particular tract,
but would be compelled to make a personal inspection and
determine whether assessment must be reduced or increased
and where it stood with reference to such average. We can
understand that, for the purpose of equalizing values as be-
tween counties where many contiguous sections of land are
under consideration and for therpurpose of making each coimty
pay its relative proportion of state taxes, such method would
be of great value by reason of the broad base for purposes of
comparison, but the relative market value for the counties
having been ascertained, then a personal inspection by the
assessor would be necessary of each tract assessed to deter-
mine whether the assessment must be reduced or increased>
that is, whether as previously assessed it was above or below the
general average.
The evidence shows that the railroad lands in St. Paul con-
stitute about eight per cent, of all the assessed lands in the
city, and, distributed among all the railroads owning ter-
minal properties, each has but a very small per cent, thereof.
These considerations, added to the notoriously gross inequalities
of assessments, compel the master to give little weight to testi-
mony of this character. On the other hand, he does not con-
ceive he is bound to accept opinion testimony as absolute but
only as a large determining element in connection with all the
facts and circumstances disclosed in the evidence, and this
has been done in reaching his conclusions. He has given care-
ful consideration to actual purchases recently made in ac-
quiring property for railroad purposes and cited to show
that they substantiate values fixed by the witnesses on either
sidei for of course they are of great value for such purpose.
Digitized by VjOOQ iC
CHAPTER VII
Pavement Over Mains
1 160. Consolidated Gas Case.
161. Consolidated Gas Case — ^Appeal to Supreme Court of the United
States.
162. Iowa Supreme Court in Cedar Ri^ids Gas Case, 1909.
163. Wisconsin Railroad Conmiission — ^Rate Cases.
164. Wisconsin Railroad Commission — Purchase Cases.
165. Opinions of Hagenah, Corey and Marston.
166. Purdiase of water plant at Trenton, Mo.
167. Dee Moines Water Rate Case, 1910-1911.
168. New York Public Service Commission in Gas Rate Case, 1911.
169. Sununaiy and conclusion.
§ 160. Consolidated Gas Case.
In the New York City Eighty Cent Gas Case involving
the right of the state to reduce the price of gas charged
by the Consolidated Gas Company the question of the
treatment of the cost of pavement over mains and services
came up for consideration. The book value of the mains
was $7,852,151 and the book value of the services was
$1,212,071. This book value was considered a fair esti-
mate of the cost of constructing the mains and services.
The estimated cost of replacing the mains was, however,
placed at $12,636,000 and the estimated cost of replacing
the services at $1,994,000. The cost of reproduction or
replacement cost of the mains and services was therefore
$5,605,000 in excess of the book value or original cost.
This difference between book value or original cost and
replacement cost or cost of reproduction was admitted to
be due to the fact that the city had at its own expense
built costly pavements over the mains of the company
and to the fact also that since the laying of the mains the
11481
Digitized by VjOOQ iC
§ 101] Pavement Over Mains 149
street subsurface had become so crowded with other sub-
surface structures asvto increase the present cost of laying
mains. Most of the mains were laid before the streets
were paved with asphalt and at a time when the streets
were not so congested with other pipes and services.
The city and state contended that the original cost should
be taken as a basis for valuation. The company^ on
the other hand, contended that the present cost of re-
placing the mains and services should be used. The
special master reported in favor of the company's con-
tention and his report was approved by Judge Hough of
the United States Circuit Court in Ins opinion of Decem-
ber 20, 1907. This opinion is quoted above, § 111.
§ 161* Consolidated Gas Ctse-^Appeal to Supreme Court of
the United States.
When this case came before the United States Supreme
Court on appeal, the city and state renewed their conten-
tion that original cost rather than replacement cost
should be used in valuing mains and services. The opin-
ion of the Supreme Court, however, leaves this matter un-
decided. The opinion does not fix a total valuation of the
property but after reducing the value of the franchise of
the company and altering other estinuites, comes to the
conclusion Uiat the rates fixed by the state were not so
low as to warrant the intervention of the court at least
until there had been an actual trial of the rates. Justice
Peckham, however, in delivering the opinion of the court,
made a general statement in regard to including property
at its present appreciated value, which, while ddubtless
intended chiefly to apply to land valuation, might also be
construed to include the valuation of mains and services
and thus to decide that the present replacement value of
the mains should be considered regardless of the question
of paving laid by the city. This statement is quoted
Digitized by VjOOQ IC
150 Valuation [i 162
above, § 112, and although its wording read in connection
with the briefs and the opinion of the lower court might
possibly be construed to settle the matter in favor of the
inclusion of the cost of pavement over mains laid at the
expense of the city, it is not believed that it was so in-
tended. The question of paving over mains is so unique
that it should not be assumed that the court intended to
dispose of it in the above general phrases in relation to
allowing the company the benefit of any increase in the
value of its property. At any rate this principle will only
apply in case pavement laid by the city be deemed to be
"property which legally enters into the consideration of
the question of rates." This is in fact the whole question
at issue and the court left it entirely undecided. The
failure of the court, in affirming the following case in
1912, to refer to exclusion of pavement over nmins is,
however, significant.
§ 162. Iowa Supreme Court in Cedar Rapids Gas Case, 1909.
In Cedar Rapids Gas Light Company v. Cedar Rapids,
144 Iowa, 426, 120 N. W. 966, 970, decided May 4, 1909,
the contention that an allowance for increased value to
pipes and mains should be made because they were under
pavements, was disapproved by the Iowa Supreme Court.
The following is from the decision of the court:
The sum of $43,580 was added owing to the alleged increase
q{ value of pipes and mains because of being underneath the
pavement. The company had laid them before the paving
was done, but it is argued that, as the value of the mains
and pipes is to be estimated when in the ground, what it
would now cost because of the pavement to put them there
should be included in determining present value. If so, the
contingency of having to remove them at the expiration of
the franchise also should be taken into account. Moreover,
the fact that most of the paved streets are paralleled by,
Digitized by VjOOQ IC
§ 163] Pavsmsnt Oysr Mains 151
unpaved alleys or parkiiigis in which pipes might be laid with-
out removing the pavement, and possibly with less danger from
electrolysis, is entitled to consideration. Nor is it to be for-
gotten that pavements yield to the ravages of time, and that
with new pavements new pipe may be laid. Undoubtedly the
values of the pipes are somewhat enhanced because of their
location^ but the entire immediate cost of opening and replac-
ing the pavement is not the criterion for value which should be
adopted.
The decision in the above case was aflSrmed by the
Supreme Court of the United States, March 11, 1912
(223 U. S. 655). Justice Holmes in delivering the opinion
of the court does not refer to the question of pavement
over mains.
§ 163. Wisconsin Railroad Commission —Rate Cases.
In the numerous valuations made by the Wisconsin
Railroad Conunission for both rate and municipal pur-
chase purposes there has been no allowance for pavement
over mains unless such pavement has actually been laid
at the expense of the company. In City of Ripon v. Ripon
Light and Water Company, 5 W. R. C. R. 1, 10, decided
March 28, 1910, the Conmiission'says: ^
Every legitimate expenditure in adapting the utility to the
demands of progress and community growth is a proper charge
to construction, and as such the investment therefor is en-
titled to participate in the distribution of the earnings from
operation. Obviously expenditures for pavement incurred
by the utility in response to assessments levied therefor by
the city, or the cost of cutting through such pavement for con-
> Other rate cases in which the same rule was adopted by the Wiaconsia
finmmuMnnn are: State Journal Printing Co. v, Madison Gas and Electrio
Co., 4 W. R. C. R. 501, 554, decided March 8, 1910; Ashland t^. Ashland
Water Co., 4 W. R. C. R. 273, 307, decided November 1, 1909; City of
Radne v. Racine Gas Light Co., 6 W. R. C. R. 228, 240, decided January 27,
1911; City of Beloit t^. Beloit Water, Gas and Electric Co., 7 W. R. C. R
187, 233, decided July 19, 1911.
Digitized by VjOOQ IC
152 Valuatiok [ § 163
struction purposes and its replacement, are proper capital
charges. It does not necessarily follow that the utility is to
capitalize expenses for municipal betterment in which it has
not participated and where such accruing benefits to the
utility are remote and incidental, and thus compel the sub-
scribers for utility service to pay increased rates because of
public improvements. The improvement is not a proper ele-
ment of value where the pavement has not been paid for by
the utility, nor any expense in connection with it directly in-
curred, in. determining a value which shall serve as the basis
fQ^-an adjustment in rates. The item of "Paving" in the ten-
tative valuation is for this reason excluded.
In re Application of the La Crosse Gas and Electric Com-
pany, 8 W. R. C. R. 138, 162, decided November 17, 1911,
the Commission considers the question of whether, al-
though pavement over mains be excluded from a valua-
tion for rate purposes, it should nevertheless be included
when considering the annual amount to be set aside from
income for depreciation. The Conmiission says:
Since the hearings of this case, the petitioner, the La Crosse
Gas and Electric Company, submitted an argument wherein
it declares that, while for rate-making purposes it might not
be proper to include in the valuation all of the cost of pave-
ment overlying conduits and mains in figuring the return on
the investment, as all of the pavement was not actually taken
up and replaced by the company, for the purpose of figuring
depreciation reserve the cost of all such paving should be either
included in the depreciable value or the rate of depreciation
increased, as the company will eventually be compelled to
bear this expense in future renewals of gas mains under ex-
isting pavement. The return for depreciation, to which a
utility is justly entitled, is usually the sum which set aside
annually will be suflBcient, at the end of the useful life of the
equipment in which investment has been made, to replace
the property in question. But when investment has not
been made by the company and the cost is borne entirely by
Digitized by VjOOQ IC
§ 164] Pavement Over Mains 153
the community, it is not clear that these expenditures by the
public represent anything for the replacement of which the
company is entitled to return. As the original paving by the
company is customarily considered construction expense and
is added to the company's investment in physical property,
in like manner anticipated paving, if it is not in reality a re-
newal of pavement formerly laid and paid for by the utility,
may perhaps be considered new construction cost more properly
than renewal cost, even when undertaken in connection with
the renewal of other materials. Viewed in this light, both
interest and depreciation on paving should be deferred until
such time as the paving m question shall, for the first time,
be taken up and replaced by the company.
§ 164. Wisconsin Railroad Commission —Purchase Cases.
In re Appleton Water Works Company, 6 W. R. C. R.
97, 122, decided December 7, 1910, involving the valua-
tion of a water plant for purposes of municipal purchase,
the Wisconsin Raibroad Conmiission says: ^
It is not the intention in such consideration of the subject
to deny that the cost of reproducing the plant new, under the
existing conditions, should include such estimated cost, but
the inquiry was there directed more particularly to ascertain-
ing the cost of reproducing the plant new in the manner of its
actual construction. . . . For the purpose of the present in-
quiry it is conceded that the cost of reproduction new, in-
cluding the item of paving, must be regarded as an eviden-
tiary fact in reaching a final conclusion, and it may be added
that in no case, either for rate-making purposes or other-
wise, has the Commission ever omitted from consideration the
item of paving in ascertaining the cost of the reproduction
new. It has, however, in rate-making cases, also considered
as having a probative effect, the cost of reproduction new
* Pavement laid at the expense of the city was exeluded in two other
valuations for purpoaes of municipal purchase: Re Fond Du Lao Water
Co., 5 W. R. C. R. 482, 492, decided August 19, 1910, and Re Manitowoc
Water Works Co., 7 W. R. C. R. 71, 88, decided June 27, 1911.
Digitized by VjOOQ IC
154 Valuation R 165
under conditions as existing at the time of the original con-
struction of the plant.
§ 165. Opinions of Hagenah, Corey and Marston.
William J. Hagenah, in his valuation for rate purposes
of the property of the People's Gas light & Coke Com-
pany for the Chicago City Council, April 17, 1911, ex-
cludes the value of pavement over mains unless such pave-
ment has been laid at the expense of the company. The
same position is taken by C. L. Corey, C. E., in a paper on
Rates for Gas Service, read before the nineteenth meeting
of the Pacific Coast Gas Association.' According to a
statement in the Engineering News a valuation of a water
plant in Waterloo, Iowa, for purposes of municipal pur--
chase made by Prof. A. Marston included an allowance
for pavement over mains laid at the expense of the city.^
§ 166. Purchase of water plant at Trenton, Mo.
In the purchase of a waterworks plant at Trenton,.
Mo., the value of pavement over mains was excluded on
the theory that if the mains were to be reproduced at
present they would not be laid in the paved streets but
in unpaved alleys. A statement by Bums and McDon-
nell in regard to their appraisal of this plant contains
the following: ^
The valuation of this plant was made in 1906. Trenton
at that time was blessed with a City Council, many of whom
had ideas of their own regarding how an appraisal should be
made and they entered into negotiations with the water com-
pany on the basis of the report submitted by Mr. Bums, modi-
fied, however, in the following particulars: The city officials
conceived the idea that streets that had been paved caused
* Printed in the American Gas Light Journal, October 23, 1911, p. 259.
* '^Valuation for City Purchase of the Property of the Waterloo (la.)
Waterworks Company/' by A. Marston, Engineering News, April 22,
1909, p. 424.
^ Printed in the Engineering Record, May 8, 1909, p. 616
Digitized by VjOOQ iC
§ 167] Pavement Over Mains 155
a corresponding depreciation in the water pipe under the pav-
ing. The argument advanced was that the water main could
serve the property just as well if laid in an alley in the rear of
the property as though laid in the street, and that if laid in
the alleys it would be easier to maintain, easier to tap, less ex-
pensive to rep^r, would save digging up the pavement in a
great many places, and, therefore, that it was a decided detri-
ment to the city to have the water pipe imder the paved street
if this could possibly be avoided. So far as known to us, this
question has never been specially passed on by the courts,
but the officials of Trenton used the argument with such force
that they finally purchased the waterworks at $2,000 less than
the valuation submitted by Mr. Bums.
§ 167. Des Moines Water Rate Case, 1910-1911.
This question was considered also in the master's report
in Des Moines Water Company v. City of Des Moines.
This was a valuation of a water plant for rate purposes.
Thirty-eight miles of pipe had been laid in streets prior to
the paving thereof. The master said: ^
Accepting the reproductive theory as the only available
one imder existing circumstances, the primary question is,
what would it be worth to reproduce the mains of the com-
plainant company as they exist in the streets of the city of
Des Moines at the present time? . . .
I know of no way in which the true worth of a new plant
of equal capacity, efficiency and durability, with proper dis-
counts for defects in the old and depreciation for use (which
the Supreme Court of Iowa says should be the measure of
value rather than the cost of exact duplication) can be ob-
tained, without taking into account the necessity of laying
the pipes of such new plant beneath the pavements.
In approving the report of the special master, Judge
Smith MePherson discusses but does not decide this ques-
*l>e8 Moines Water Co. v. City of De8 Moines, no. 2468, in equity,
Rqx>rt of George F. Henry, jnaster in chancery, Circuit Court of the
United States, filed September 16, 1910.
Digitized by VjOOQ IC
156 Valuation [ § 168
tion as to the incliision of pavemeht over mains laid at
the expense of the city.^
§ 168. New York Public Service Commission in Gas Rate
Case, 1911.
The most exhaustive discussion of the problem is con-
tained in the opinion of Commissioner Maltbie in Mayhew
V. Kings Co. Lighting Co., 2 P. S. C. 1st D. (N. Y.) — ,
decided October 20, 1911:
The practical effects of such a theory are interesting and
important. Suppose a locality at the time a gas company was
started and its pipes laid were content to have impaved or
cheaply paved streets, cobblestone, macadam or gravel being
used. Suppose that the people come to demand better paving,
being dissatisfied with earlier conditions, and that asphalt,
brick or granite block with a concrete base is laid throughout
the area. Naturally, the people appreciate that they must
pay the cost of the repaving; but according to the theory of
counsel for the company, the gas consumer must also pay more
for gas. In other words, every time the streets are improved,
not only do taxes or assessments go up, but higher gas rates
are justified, notwithstanding the fact that the company may
not have paid one dollar in connection therewith. If this
theory is correct, citizens must consider in connection with
every civic improvement its effect upon rates for gas, elec-
tricity, telephone service, water, transportation and every
other service which involves the use of the subsurface of the
streets. If such improvement increases the cost of repro-
ducing the undertaking suppl3ring such service, higher rates
will thereby be justified than would be reasonable before such
improvement is made.
Applying the theory of counsel to the case in hand, he asks
that in toto about $250,000 or $300,000 be added in determining
the ''fair value" of the property, such sum including not merely
the net cost of the paving, but ''overhead charges" amount-
'Des Moines Water Company p. City of Dee Moinee, 192 Fed. 193»
September 16, 1911.
Digitized by VjOOQ IC
§ 168] Pavebobnt Oyer Mains 157
ing to 20 per cent, or thereabouts. A return of 10 per cent,
thereon would be from $25,000 to $30,000. Upon the basis
of actual sales for 1910, this is equivalent to from 4 to 5 cents
per thousand. Thus, the net result of counsel's theory is that
this Ck>mmi88ion is asked to fix a rate higher by 4 or 5 cents
than would otherwise be reasonable, and the reason offered
in essence is that since the Kings County Company laid its
mams and services the City of Brooklyn and later the City of
New York has materially improved the paving over those
pipes without expense to the company.
The company's counsel apparently relies upon a single
thesis to maintain his theory. He may not claim that the
pavement is the property of the company, for it is not in any
degree. The company may not alter the pavement with-
out the city's permisaon, nor sell, transfer or remove it, and
in case the company does take up its pipes and leave the street,
the pavement must be restored. Secondly, the company did
not lay the new paving. It was laid by the city after the com-
pany's pipes were in the ground. In the third place, the new
paving represents no expenditure upon the part of the com-
pany. This fact is important, for it is conceivable that a
company might not own certain property, might not have ac-
tually constructed it, and yet the expense of such ccmstruc-
tion, if paid by the company, might properly be included in
the amount upon which the company would be entitled to
earn a fair return. But in this case, the new pavement under
discussion does not represent any investment or expendi-
ture by the company. The relaying of the original paving
does and it has been included in ''net cost," as above set forth.
If one were to estimate the cost to reproduce as new the
property that exists to-day, the present paving would have to
be refdaoed when the streets were opened for the laying of
mains and services. Apparently this is the only basis upon
which the company's contention is founded. The cost-of-
reproduction method may be the only method which can be
used in some instances, but to follow it to the last extremity in
all cases, ignoring all other considerations, not only leads to
absurd oondusionB, but runs counter to judicial decisions. . . .
Digitized by VjOOQ IC
158 Valuation [§ 168
There are two other arguments that have not been submit-
ted in this case, but to which reference should be made in^this
discussion. One is that if a competing company were to build a
gas system, it would be obliged to pay for the existing pave-
ment over its mains and services as it would have to replace it
during construction. True! But does it follow that gas rates
would in practice be based upon the cost of the most expensive
service? Even the maximum to be fixed by law would not of
necessity be based upon the cost of the most expensive service.
However, this argument is irrelevant because it is the policy of
this State that public regulation of rates shall take the place of
competition and that unnecessary duplication of plant shall be
avoided. The State is to protect the consumer against unreason-
able rates. But if the State must fix rates upon the basis of
competitive supply, it is evident that the consumer has lost the
advantages of competition and not gained those of monopoly.
It is also argued that if land should be taken at its present
value, mains and services should likewise be appraised at the
cost to reproduce; that the increase in the value of the land is a
social increment; that improvement in paving is also a social
increment; and that if one is to be recognized as belonging
to the company, the other should be. Doubtless there is some
similarity, and so far as there is, there is equal injustice in
allowing the company to make a profit upon that increase. In-
deed, it is not yet clearly settled by the courts that in all cases
land shall be taken at appreciated value and the company al-
lowed to increase its rates because of such growth. But pave-
ment that is not owned nor laid nor paid for by the company
is very unlike land.
In the first place, land is owned or leased by the company;
the pavement in question is neither owned nor leased. The
company may sell the land it has and buy other land; the com-
pany has no such right over pavement, and if it removes its
pipes, the pavement remains.
Secondly, the company pays for land; it does not for new
pavement. Land is a necessary factor in gas production and
distribution; pavement is not. It matters not whether the
streets are paved with the most expensive material or allowed
Digitized by VjOOQ IC
§ 169 ] Pavement Oyer Mains 159
to remain in their natural state. Repairs may cost more in
the former case, but such expenses are paid for out of income
and not from capital.
Thirdly, the precise land used is selected by the company;
the nature of the pavement is fixed by the public authorities.
If the company finds its land not well adapted to its needs or
too valuable for gas purposes, it may sell and purchase loca-
tions elsewhere. Thus, a company may secure the increase in
value for itself. But there is no known way whereby a company
may sell the pavement over its mains and substitute another
kind. Pavement is wholly beyond the control of the company.
§ 169. Summary and conclusion.
The question whether pavement over mains laid with-
out expense to the company should be included in fair
value for rate purposes was decided in the affirmative by
the Circuit Ck)urt in the Consolidated Gas Case (see
§§111, 160) but on appeal to the Supreme Court of the
United States the decision as to this point is not clear
(see §§ 112, 161). The Iowa Supreme Court has ruled
against the inclusion of such pavement and while its de-
cision in the case was affirmed by the Supreme Court of
the United States there is no reference in the latter opinion
to the question of pavement (see § 162). The position
taken by the Iowa court has been followed by the New York
Public Service Commission for the First District (see § 168)
and in purchase as well as rate cases by the Wisconsin Rail-
road CJonunission (see §§ 163, 164). Pavement laid at the
expense of the city is of course excluded from an estimate
of actual cost. Whether or not it should be included in
cost of reproduction depends on whether that term is
taken as the actual cost at present prices of labor and
materials and under present physical and other conditions
of constructing a complete duplicate plant, or the neces-
sary cost at present prices of labor and materials of con-
structing a plant in the way and under the conditions im-
Digitized by VjOOQ iC
160 Valuahqn [§ 169
derwhich the existing plant was in fact constructed. The
latter is the more generally equitable interpretation of the
cost of reproduction method as is shown above, §§ 81-84.
Under this interpretation the cost of pavements laid by
the city will not be included in an estimate of cost of
reproduction. Of course if in a particular case it is shown
that the company put down its pipes or conduits before
they were needed with a view to avoiding the cost of
cutting through the pavements it might be equitable to
include an allowance for interest up to the time that such
pipes or conduits were actually put into service. Every
actual investment or sacrifice by the company should be
considered, but the acceptance of this rule precludes the
consideration of any element that is not dependent on
cost or sacrifice. CJertainly if we accept as governing the
equitable rule of a fair reward based on the cost of the
service rendered, pavement over mains laid without ex-
pense to the company cannot logically be included in
fair value.
Digitized by VjOOQ iC
CHAPTER VHI
Proimty Donated « Acfvired Withmt Cost
( 180. State railroad appraisals.
181. Minnesota Supreme Court on railroad grants, 1897.
11^. GaEfoTtaa Supreine Odurt on water servfi^es, 1897.
183. United States Cirtsuit Jvdge Morrow cDiehides feifoes not built bf
company, 1911.
184. Wisconsin Railroad Commission on services provided at con-
sumer s estpense.
185. Oj^inion of C. L. Cof^y on Mrvioes fwuished by consumer.
186. State and city aid in grade sepamtion improvements.
187. City's grade separation contribution considered by New York
Public Service Commission.
188. Grade separation contributions in appraisal for oapitlJisation.
189. Conchnoa as to grade separation contributions.
190^ Staitement of problem of donated property.
191. Contributions by the company.
192. Tlie more eqoitable rulift.
§ 180. State raiboad appraisals.
In the variaufi dtste railroad i^raisals, land has been
taken at its present value irrespective kA the f at^t that in
some of the states much of the land for right of way was
donated by the national, state or local governments or in
some cases by individuals. The western trunk lines have
received e&onnous land grants and in addition have been
granted & right of way across the public domain. In the
Washins^n railroad appraisal made by the Washington
RailiDwl Commission, an estimate was made both of the
ori^nal cost of land for ri^t of way and other railway
purposes and of the present reproduction cost of such
Uund. The Commission found that for %bt Northern
Pacific Hailway the original cost to the company of right
of way and real estate in the State of Washington was
11 [161]
Digitized by VjOOQ IC
162 Valuation [§ 180
$3,157,167. The cost of reproduction of its right of way
and real estate was estimated at $32,862,872, or more
than ten times the original cost. The reproduction cost
is high because it includes $26,000,000 for terminal land
in the cities of Seattle, Tacoma and Spokane, that has
rapidly increased in value. The original cost is low be-
cause nearly all of the right of way was given by the
government. The company received a grant from the
United States for right of way purposes along its main
line, 400 feet in width, across public domain and lands
owned by the United States. Through incorporated
cities and towns the Commission allowed the company
the present value of the full width of its 400 foot right of
way. Outside of such cities and towns the Commission
allowed the present value of a strip of land 100 feet wide
for right of way purposes.^ The Wisconsin Railroad
Commission refers to this problem in a passenger fare
case, Buell v. Chicago, Milwaukee and St. Paul Railway
Company, 1 W. R. C. R. 324, 366, decided February 16,
1907: 2
It is, of course, true that a large proportion of the right of
way was secured free and that a considerable part of the bal-
ance was obtained at a low cost. In addition to this it is also
a fact that the cost of the plant to the company was consider-
ably reduced by land grants and local aid. Whether the con-
struction account has been credited by the receipts from these
and similar sources is doubtful. Theoretically all such aids
should have been taken into account; but from a practical
point of view, or for the purposes of this inquiry, it may be a
question whether items of this character should be deducted
from the capital accoimt at this time.
^ See "Findings as to Value of Railroacb/' in second and third annual
report, Railroad CommiBsion of Washington, 1907-1008, pp. 127-449.
' For decisions of the Wisconsin Commission in subsequent cases, see
tl84.
Digitized by VjOOQ IC
{ 181] Property Donated 163
{ 181. Minnesota Supreme Conrt on nilroad grants, 1897.
The case of Steenerson v. Great Northern Railway Com-
pany, 69 Minn. 353, 72 N. W. 713, 722, decided October 20,
1897, involves the valuation of a railroad for rate pur-
poses. In this case the court took cost of reproduction as
the g^ieral basis of fair value. But in regard to land do-
nated by the state. Judge Canty states that, ''In de-
termining whether the rates fixed by the Commission are
confiscatory, we have not found it necessary to determine
the effect of the very important fact that this railroad
received from the state a very large and valuable land
grant.''
{ 182. CaUf omia Supreme Court on water senrices, 1897.
The case of San Diego Water Company v. City of San
Diego, 118 Cal. 556, 50 Pac. 633, 639, decided October 9,
1897, involves a valuation for rate purposes. The lower
court held the municipal ordinance unconstitutional but
was reversed by the state supreme court and the cause
remanded for a new trial. The decision in this case wils
rendered by a divided coiurt. Six of the seven judges con-
curred in the findings but four separate or concurring
opinions were rendered. The opinion of Judge Van Fleet
concurred in by two other judges contains the following in
regard to services:
It may be added that when, as appears to have been the
case in this instance, portions of the company's expenses are
specifically repaid by the consumers, such expenses should be
eliminated from the computation. This will apply, at least,
to the ''taps" put in for private consumers.
{ 188. United States Circuit Judge Morrow excludes fences
not built by company, 1911.
San Joaquin and Kings River Canal & Irrigation Com-
pany V. Stanislaus County, 191 Fed. 875, 885, decided
September 18, .1911, is an action to enjoin the enforce-
Digitized by VjOOQ iC
16t VaIiUatiok f$ 188
meat of inigation crater rates fixed by the county boards
ofsupervisoiB. Atempoiuryinjnnctioiihadbeengraiited.'
Subsequently the case was referred to a q^ecud master and
the master reported in favor of the legality of the proposed
rates and this finding is in the present case approved
by the C^euit Court. Circuit Judge Morrow says (at
page 885):
The master found that the rights of way for complainant's
canab were of the value of $144,119. To this finding no ex-
ception has been taken, but, in addition to this valuation, the
complainant claimed before the master, and urges the claim
here for the valuation for 286 miles of fences along the canals
at a oost of 1148.50 per mile^ making $42,471. The master
rejected this claim for the reason that it was not supported
by evidence. There is no evidence in the record that the com-
plainant built any fences along its right of way. In complain-
ant's brief before the master it is stated:
"That they were unable to prove that the company itself built
these fences, but the books of the company refer to these fences
as early as 1877. If we admit that the adjoining owners built
the fences, still, if the canal company should fence its right of
way, it would be liable for one-half of these fences. C. C.
Cal., § 841. Undoubtedly a new company would be compelled
to pay the cost of these fences if they attempted to condemm
a right of way through this country."
The master held that the inquiry he was called upon to
make was the cost of reproducing the plant at the time the rates
in question were fixed, and that such cost of reproduction
must be applied to the property that was owned by the com-
plainant. He was of the opinion that if the fences had not
been built by the complainant, and therefore did not belong
to the complainant, it would not be entitled to hav^ tibem valued
as a part of its property. I see no reason for suBtaining the
ezceptitm to tiiis finding.
*San Joaqtun and IQngs River Canal ft Irrigation Co. v. StaoidaOB
Ocranty, 163 Fed. 667.
Digitized by VjOOQ iC
1 164 Prohbbtt Donated 145
1 184. Wlacmabk KaUsmmI Cflnmiiwinn mk Moiett pfo«i4«d
at consumer's expense.
The Wisconsin Railroad Commission in Tighe v. Clinton
Telephone Company, 9 W. R. C. R. 117, 126, decided
December 2, 1908» holds that it is compelled under the
Public Utilities Law to value all property no matter how
obtained and consider this valuation in taking action with
respect to rates and service. Durkg the early history
of the Clinton Telephone Company a ecHisiderable paii
of the work of construction was done by farmers who re-
ceived no pay for their services. Yet the Commission says
(at page 126):
Nor can the fact, that a part of the ear^ coostructiaa wm
gratuitously done and some poles ffveu outright without oast
to the company, in any manner compel a lower vahif^fcioft under
the provisions of the law. The Commission is required to value
all the property used and useful for the convenience of the
public. The law says nothing about deducting the value of
the property owned by the company but originaRy donated
it. In fact, if the whole of the Clinton Telephone Gbmpany's
property had beea jwesented to it without a cent of expend-
iture on the part e£ the pieseat owners, the ir^ltiation of the
Commission would have to be identical with whait it now is,
For the purposes contemplated here, the Public Utilities Law
does not inquire into the manner in whieh property of tttiKty
corporations devoted to the public use was eri|^umy obtained,
whether by purchase, inheritance, gilt or thetl. The law mmply
compels the Oommission to value this pvoperty and to eonsidei
this vahiatien in taking official action witk lespeet to tales
and serviee*
In Aafakuid n. AaUand Water Company, 4 W. it C. R.
273, 306, decided November 1, 1909^ also a vahiafciM £ai
rate purposes, the Conmtiission eonsideffs the questioA of
land donated by the city and of service connections made
at the expense of consumers. The Conunissioa ffiaffinn»
Digitized by VjOOQ IC
166 Valuation [§ 184
the pofidtion taken in Tighe v. Clinton Telephone Company
but adds the following:
From a legal point of view the same position will doubtless
have to be taken with respect to services paid for by consumers,
although we are frank to say that from the point of view of
equity full consideration may well be given to the fact that
a large number of services have been paid for by private con-
sumers, and that certain lands have been donated to the
company by the municipality.
This instead of a reaflSrmation as stated is a substantial
reversal of Tighe t^. Clinton Telephone Co. The reversal
is made unmistakable in later decisions^ for example:
In City of Washburn v. Washburn Water Works Com-
pany, 6 W. R. C. R. 74, 92, decided December 6, 1910,
the Conunission says: ^
It is well understood that, as a matter of equity, the Com-
mission does not include services paid for by consumers in
the valuation of public service property for the purpose of
establishing rates.
Again in City of Beloit v. Beloit Water, Gas and Electric
Company, 7 W. R. C. R. 187, 215, decided July 19, 1911,
the Conunission says:
It appears to be clearly established that the charge assessed
against the consumers by the company for the installation of
services has been in the aggregate sufficient to cover the cost of
this work to the company. In view of these facts we are of
the opinion that the value represented in the services under
consideration, and for which the consumers have paid, is not
a fair element in the valuation for the purposes of this case.
This applies also to the value of the so-called private mains to
the amount which the consumers have pidd and have not been
ireimbursed by the company.
« See also City of Ripon v. Ripon Light and Water Oo., 5 W. R. C. R.
1, 10, decided March 28, 1910.
Digitized by VjOOQ iC
$ 185] GraJ>E SEPARimON CoKTRIBUnONS 167
§ 186. Opinion of C. L. Corey on services furnished by con-
sumer.
The same rule as to valuation of gas services is expressed
in a paper on Rates for Gas Service by C. L. Corey, C. E.,
read before the nineteenth meeting of the Pacific Coast
Gas Association: ^
Only that portion of the service belonging to the company
should be included, and if consumers have paid for any portion
of the service that portion should not be considered as belong-
ing to the company. The total value of the services should
represent only those actually owned by the company, and
in general should not include any services, or reproduction
of any services, within customers' premises, unless the cost
of the same has actually been met by the company.
§ 186. State and city aid in grade separation improvements.
A number of cities and states have spent enormous
sums in paying a portion of the expense of track elevation
or d^ression or the construction of highway bridges and
subways incident to the elimination of grade crossings.
The states of New York and Massachusetts and the
cities of Boston, New York and Philadelphia have spent
millions of dollars in this work. The question now arises
as to how these investments of cities and states will be
treated in a determination of the fair value of the railroad
for rate-making purposes. Judge Chas. E. Otis, Special
Master in Chancery in the Minnesota Rate Cases, has
included in the fair value of the road the cost of three
bridges built at the expense of the City of Minneapolis,
over the Minneapolis and St. Paul Railroad. He says: '
* Printed in American Gas Light Journal, October 23, 1911, p. 259.
*Shepard v. Northern Pacific Ry. Co., United States Circuit Court,
Minnesota, Third Division, Report of Chas. £. Otis, Special Master in
Chancery, September 21, 1910. Circuit Judge Sanborn approved the re-
pcM of Uie master but his opinion does not refer specifically to this finding
(1S4 Fed. 705, April 8, 1911).
Digitized by VjOOQ IC
leS Valuatiok [§ 187
It was claiiDed hy tka Stote that the three biidge^ menticaMd
were built by the city and for this reason no allowaaoe was
made therefor. But as they apparently form a part pi street
highways, as the law now is, their repair aad renewal a^ re-
quired must be borne by the company and the city could not
have been compelled to construct them in the first instance
if the law had been properly interpreted and observed. Their
reproductioQ cost should have been allowed at the sum of
$54,58a
§187. City's grade separation contribution considered by
New York Public Service Commission.
The City of New York coutributed about one-half of
the expense of depressing in paiTt and elevating in part the
Brighton Beach division of the Brooklyn Union Elevated
Railroad. The city spent about $800,000 for this purpose.
A case came before the Public Service Cdmmission, in-
volving the reasonabteness of a ten cent faie to Coney
Island.^ The dissenting c^Mnion ol Conunissioner Maltbie
in this case contains the foHowing:
In the fourth place, contributions by the City should be
deducted. The City of New York has paid to the Brooklyn
Union Elevated Railroad Company approximately $800,000.
No company ought to be allowed to capitalize such contribu-
tions or charge a rate which will 3rield a fair return upon these
contributions. With equal prc^riety the companies could churn
the right to earn profits upon the ci^pitali^ed vahie of the
streets and of the Brooklyn and WiUiamsburg Bridges, which
they have been allowed to uae practically without charge.
The capitalization of fraiv^hises, a procedure prohibited by
law, would be Booire plausible^
The inclu&ioa or exclusion of the city's contribution was
not decided or considered in the majority opinion in this
case.
' MonKeimer v. Brooklyn Ubioq Elevated Raihoad Co., 2 P. 8. C.
let D. (N. Y.) 00, March 8, 1910.
Digitized by VjOOQ IC
S 188] Grade Separation CoNTRiBunoNd
§ 188. Grade stparatkui coolrikutlMs la anmlMl f er ciffc-
teHatioii.
This subjeet is diseusaed ifi a wport by Geovge F.
Swain, En^ne^ in Cliarge» to the Maasackusekto Joint
Board on the validation ol assets and liabilities of the
New York, New Haven and Hartford Raikoad." This is
a valuation for purposes of capitaUsatioa. Mr. Swain
says (at page 88) :
In the appraisal which has been made, the endeavor has
been to ascertain the cost of reproduction new of the exist-
ing lines. The existing line, however, inchides some elements
involved in the elimination of grade crossings which have been
partly paid for by the State, and by the cities and towns.
In Massachusetts, for instance, 35 per cent of the cost of
eliminating grade crossings is paid for by the Commonweattk
and the city or town. In this vahiatioAi however, it has not been
considered that the Commonwealth or the town has thereby
acquired any perpetual or proprietary intevest in the prop-
erty of the raikoad, but that its contribution was for the pur-
pose of remunerating the company for the destruction of ex-
isting property involved in the charge, and for the cost of
protecting traffic during the alterations, as welt as for the
better accommodations and greater safety afforded to the pub-
lic. It would have been impossible to adopt any other course,
and the one described seems eminently fair. It is not con-
tended, I presume, that where grade crossiug9 are abolished the
Commonwealth or the town becomes thereby the owner of
any portion of the railroad.
§ 189. Conclusion as to grade separation contributions.
In certain cases of grade separation the contribution
of the state and city is not more than sufficient to pay for
the necessary structures and reconstruction within the
street or highway and outside of the lines of the railroad's
*Publiflhed in Report of the Maasachusetts Joint CommiaBion on the
New Yorky New Haven & Hartford Railroad Company, Febniuy 16,
1911, pp. 51-154.
Digitized by VjOOQ IC
170 Valuation R 190
right of way. Where this is true it is entirely proper to
allow the company the full value of structures within the
lines of its right of way. And in case the company pays
the entire expense of grade separation including the cost
of street reconstruction, the cost of such street reconstruc-
tion should be included in a valuation for rate purposes.
It seems just that the company should receive a retiun on
the cost of all the improvements that it has made with its
own capital but not upon such as have been made at the
expense of the city or state. Otherwise the public is
doubly taxed; once to pay the cost of the improvement
and again to pay interest and profits on its own invest-
ment. The argument that the public's contribution to
grade separation may be considered as a contribution not
for construction, but as made *'for the pinT)ose of remu-
nerating the company for the destruction of existing prop-
erty involved in the change and for the cost of protecting
traffic during the alterations" (see § 188) seems rather
fanciful in view of the great advantage of grade separation
to the railroad from many points of view and in view also
of the state's undoubted legal right to require grade sep-
aration at the sole expense of the railroad.'
§ 190. Statement of problem of donated property.
The problem as to donated property is well stated in
an article on Valuation of Railways in the Railroad Age
Gazette of January 29, 1909, page 222:
Conflicting opinions are entertained with respect to the
status which should be assigned, in connection with a val-
uation, to donated property — right of way, station and termi-
nal grounds, government land grants, and the like, to which
» On this point see N. Y. & N. E. R. R. Co. v. Bristol, 151 U. S. 656, 14
Sup. Ct. 437, 38 L. ed. 269, Februaiy 5, 1894; State ex rd. City of Minne-
apolis V. St. P., M. and Manitoba R. R. Co., 98 Minn. 380, 108 N. W. 261, af-
firmed Northern Pacific Ry . Co. v. Minnesota ex rd, Duluth, 208 U. S. 583,
28 Sup. a. 341, 24 L. ed. 630, February 24, 1908.
Digitized by VjOOQ IC
§ 1911 Pbopsbtt Donated 171
no considerable ooet attaches. Is it proper that it should
be made a constituent of that value for the use of which the
public may be taxed in the interest of the donee? If so, should
it be appraised at its full worth in the market, or only at
the cost to apBppriate it? Is a grant of land, which must
be converted into cash and reconverted into transportation
property, different in any important particular from a gift
of right of way, which enters directly into the transportation
plant? Is the case affected by the origin of the gift, whether
public or private, or by the consideration that it is devoted
to a public use? It may not seem consonant with the prin-
ciple that cost only should be capitalized, and sentimentally it
may not seem fitting that the public should be assessed for
the use of that which it has donated to a private corpora-
tion to be employed in the public service; but, much as one
might incline to the opposite view, it is difficult to escape the
conclusion that donated property ranks at its cash equivalent
with that purchased or condemned. Upon conveyance of the
gift estate title vests in the donee; if there are no qualifica-
tions, such title is absolute; and the use of the property, and
the right of enjoyment of the profits arising from it, are nec-
essary incidents of ownership.
It may, however, be recalled that this land has been do-
nated to a private company because that company is
undertaking to supply a public utility at reasonable rates
6t charge. Under the circumstances would it seem fair
and equitable for the company to so adjust its rates as to
produce for itself a fair return not only on its own invest-
ment but upon the investment that the public has do-
nated? Would it be unreasonable to assume that these
donations were made with the assurance that rates would
be fair and equitable imder the circumstances and with
due regard to the respective contributions and equities
of the company and the public?
1 191. Contributions by the company.
Hie inclusion or exclusion of a particular item in a vai-
Digitized by VjOOQ IC
m Valuation fim
uatioa Sot late purpoBesi is aot always depmdoat om
whether the eompany holds the legal title to such pio|^^
erty. Public utiMty eompamee sometimes iiiYeet thdr
funds in struetures to which wh^i eonapleted they ean
claim no title. They may perhaps be said to have do-
nated these structures to the public. A railroad is con-
structed through a city and is required to separate all
grades between the railroad and the public streets. Cer-
tain streets will have to be depressed and carried lUKler
the railroad and others raised and carried over the rail-
road. Streets and pavecaents will have to be recon-
structed and in some cases water aad gas pipes asid sewers
relocated. AU this expense wiM be home by the raikoad
and yet it will have no title to this property keated ki the
streets. Again take the case of the street and elevated
railroads operating over the East River bridges in New
York City. The track, equipment and signal system is
constructed at the expense of the companies but title to
such property vests in the city and the property is oper-
ated under an indeterminate permit. Similarly a gas,^
water or electric company may construct at its own ex-
pense service connections to which it can claim no title.
The question comes up also m connection with street
paving laid at the expense of a street railway, gas, water
or electric company. A gas company that is required to
cut through and replace street pavement in order to fay
its mains has no title to the pavement thus laid at its
expense. A street railway company is usuafly required to
pave between its tracks and eighteen inches on each side
thereof. It has usually been held, however, that title to
such pavement vests in the city. Yet the justice of in-
cluding such pavement in a valuation of the railway for
rate purposes is seldom seriously questioned.
In the Chicago Street lUMway Settl^n»t of 1908, «dk^
corop(»iiips wcire aUowed the present vahie of street pave-
Digitized by VjOOQ IC
i 191] PBOPfirrr Donated 178
m^its occupied by iBilway Uvcks. Tbie Traction Valua-
tion Gommission stated in its report of 1906, that the
Commission had been advised by the city's special cotinsd
that the legal title to the pavement was in the City of
Chicago and not in the companies, and that if the com-
panies were entitled to the value of the pavement in the
pending negotiations, it must be upon the theory that
their rights of occupancy in the various streets are of more
value when the right of way is paved than when it re-
mains unpaved. The Cmmnission fixed the present value
of ike paveoients at $4,342,035| but expressed no apinion
as to whether the whole or a part of such amount should
be included in the value for the purposes of the proposed
settlement. The total valuation as finally agreed upon
was a compromise and it was not definitely stated what
portion of the same was inchided as compensation for
pavements.
In the Cleveland Street Railway Settlement of 1908,
representatives of the company and city agreed in allow-
ing SI, 721 ,000 for paving. Mayor Johnson contended
that the pavement was in the nature of a tax and had
never been included in the assets of the company as
assessed for taxation. The company claimed that certain
franchises recently granted explicitly provided that if the
city or another company bought them or took them over
at the end of their franchises the then physical value of
the paving should be pwd for. The city finally conceded
the entire claim of the company relative to paving.*
When the property of the Cleveland Railway Company
was revalued by Judge Tayler in 1909, he sdlowed the
item for pavement as in the 1908 appraisal. Judge Tayler
says:"
>*See ''BCieet Railway Settlement in Cleveland/' by E. W. BemiB, in
<)iiaitn9y Jounud'ef EoonomioB, Vd. 22, p. 543, August, lOOB.
" DeciaioB of United SUteft District Judge R<ibert W. Tayler in the
Digitized by VjOOQ iC
174 Valuation [§192
I have allowed the pavement item because it comes within
the general rule which I have stated. The argument for its
elimination rests upon technical grounds purely, and I think
can have no proper place in such a valuation as we are now
seeking to make. It represents actual money expended. It
represents absolute addition to capital value. It belongs
to capital account and in its depreciated form is worth all
of the allowance that I have given to it.
In the various valuations of street railways in New York
City made by the Public Service Commission for the
First District the value of pavenients has uniformly been
included.
§ 192. The more equitable rule.
Now unless there is some good reason to the contrary,
a rule in regard to donations should work both ways.
That is the rule adopted should be applicable alike both
to donations by the company and to donations by the
public. If the reconstruction of a street or the building of
expensive street approaches is a necessary part of the
expense of constructing the railroad it is only fair and just
that the company should be allowed to earn a fair return
on such investment regardless of the fact that the title to
such property is not vested in the company but in the city.
Similarly if the government has given this same company
the land for its right of way, the actual property in which
the company has invested its capital and not that part to
which it has title but which has been donated by the
government should be considered in determining reason-
able rates. Actual title and possession are not always
conclusive. The determination of a reasonable rate is an
equitable process and equity will demand that certain
property to which the company has no title should be in-
matter of the arbitration of the valuation of the property of the Cleve-
land Railway Company, December 18, 1909 (not pubtiahed).
Digitized by VjOOQ IC
§ 192] Property Donated 175
eluded and certain other property to which the company
has title should be excluded. It is the actual investment
or sacrifice on the part of the company that is entitled
to consideration r^ardless of mere title or possession.
This at least should be the general rule. There may be
cases where donations made by the public cannot be
separated from the other property or where they were
made so long ago that rights or equities have been devel-
oped in ignorance of their existence or significance and
which it would not now be public policy to seriously dis-
turb."
1* In the Alabama Rate Litigation, flpecial master W. S. Thorington in
his two reports holds that land donated for right of way must be included
m a valuation for rate purposes. In the Central of Georgia Railway case
he says (at page 121) : " The Special Master takes it to be a sound principle
of law that where property is given to a railway company for a right of way»
such property becomes as much a part of the property of the railway com-
pany devoted to the public use as does property purchased or condemned
by ity and its value is just as much to be considered for rate purposes as
is the value of any other property devoted by the railway company to
the use «>f the public." (Central of Georgm Railway Company v. Rail-
road ConDmission of Alabama, No. 261, in equity, United States, District
Court, Middle District of Alabama, Northern Division, Report of W. S.
Thorington, Special Master, January 8, 1912. Western of Alabama Rail-
way Company v. Raihoad Commission of Alabama, No. 265, in equity,
same Court and Master, April, 1912.)
Digitized by VjOOQ IC
CHAPTER IX
Property Constructed out of Surplus
i 200. Valuation of property oooBtmoted out of surplus.
201. Pfennsylvania Supreme Court in Brymer ». Water Company, 1897.
202. Maine Water Hant Condemnation Case, 1902.
208. Intenrtjtfbe OomBoerce CoauniflBion in Spokane 9. Nortlietii Pacifits,
1909.
204. Right to a rate of return adequate to construct betterments.
205. Betterments out of earnings — New York Public Service Commis-
sion, 1911.
206. Betterments out of earningB— American Tdephone and Telegraph
Company, 1912.
i 800. Yaluatioii of property constructed out of surplus.
In valuation for rate purposes the question is sometimes
raised as to whether that portion of the property that has
been constructed out of surplus earnings should receive
any different consideration from that constructed from
funds secured from the sale of securities. If a company
has charged rates, not alone adequate to pay a fair and
reasonable profit to the stockholders, but also to permit
the building out of earnings of extensions and improve-
ments aggregating as much as the total investment of the
security holders, there is some justice in the argument
that unless this has been done for the benefit of the con-
sumers it represents pure extortion. Profits in excess of
a fair return should either be distributed to the consumer
in lower rates or if used for extensions and improvements
should be deemed to be held in trust for the exclusive
benefit of the consumer. But this argument would apply
as well to excess profits that had been distributed in
dividends as to excess profits that had been used for im-
provements. It would imply that the Grovemment's right
to regulate was retroactive and failure to exercise it for
1176]
Digitized by VjOOQ iC
§200] Invested Surplus 177
a great many years would not prevent it from requiring
at any time an accoimting of all profits from the initiation
of the enterprise and a virtual refimd of any amoimts
paid to the investors in excess of a fair retimi. On the
other hand it is sometimes argued that any failure to earn
a fair return at any time in the past should give the com-
pany a right to recoupment through an added capital
value termed cost of establishing the business or going
value. Past surplus profits create a present negative
going value while past deficits create a present positive
going value. It is probable that for rate purposes neither
past f aUiure to earn a fair retimi nor past e^onings in excess
of a fair return should be considered in connection with
the fair value of the property. They are doubtless matters
worthy of careful consideration but they are questions
of return and not of cost or value and should influence the
determination of the present fair rate of return and not
that of the present fair value. Authoritative decisions on
this point are lacking. The question seems for the most
part to have been ignored. It is referred to by the United
States Supreme Court in Louisiana Railroad Commission
V. Cumberland Telephone and Telegraph Company, de-
cided February 23, 1909.^ In this case the coml; appar-
ently takes the groimd that extensions or improvements
constructed from the proceeds of the reserve set aside for
depreciation, are not to be included in the fair value for
rate purposes. Justice Peckham, however, says: ^'We
are not considering a case where there are surplus earnings
after providing for a depreciation fund, and the surplus
is invested in extensions and additions. We can deal
with such a case when it arises," *
> Louisiana Railroad Commission v, Cumberland Telephone and Tele-
graph Company, 212 U. S. 414, 424, 425, 427, 29 Sup. Ct. 357, 53 L. ed.
577, February 23, 1909.
* For a more oompleie abstract of this case, see $ 424.
12
Digitized by VjOOQ iC
178 Valuation [§ 200
In Massachusetts tbe treatment of property constructed
out of surplus is of special importance, owing to the con-
trol that has been exercised for many years over capital-
ization and rates. The Board of Gas and Electric light
Commissioners seem to have consistently held to the posi-
tion that while the property constructed out of surplus
profits undoubtedly belongs legally to the stockholders,
equitably it requires a different treatment in a rate case
from money actually contributed by the stockholders.
This is shown in the memorandum of the Commission on
the East Boston petition printed in the ninth annual re-
port of the Commission, 1894, pages &-16. The position
of the Commission is more clearly outlined in the Haver-
hill petition printed in the sixteenth annual report, 1901,
pages 9-13. This case was a petition by the mayor of
Haverhill for a reduction in the price of gas supplied by
the Haverhill Gas Light Company. The Commission,
after a hearing, reduced the price from one dollar to
eighty cents per thousand. In discussing the treatment
of property constructed out of surphis, the Commission
says (at page 9) :
The Haverhill Gas Light Company was organisied under a
special charter in February, 1863, and later in that year began
the supply of gas in Haverhill. Its cafpital stock was originally
$45,000, which was increased in 1871 to $76,000. . . .
It has enjoyed the exclusive privilege of supplying gas to the
city and people of Haverhill, and, with the exception of a period
in its earliest history, has been uniformly prosperous. Its
management appears to have been exceptionally careful and
conservative, so that, in addition to the payment of an average
dividend of about 8 per cent., it has accumulated a surplus
invested in its plant estimated to represent from $276,000 to
$300,000. It is probable that a part of this will disappear in
the near future, through the abandonment of existing plant in
making improvements whith are likely to prove necessary for
Digitized by VjOOQ iC
(2601 Investbb Surplus 179
properly snpplymg the public, but the surplus is much larger
OiBn cair be utilized for any such purpose.
It is mmecessary at this time to give particular consideration
to the wisdom or unwisdom of creating a surplus of this sise and
character, but rather to consider how it has arisen and how it
diould be treated as an existing fact. It does not appear that it
is due to extravagant prices for gas or to a niggardly policy
toward the pubHc; the prices have in fact been as low or lower
than in other companies of its class in the State, while the
quality of the service, so far as the Board has been able to as-
certain, has been equal to the best. This accumulatimi appears
rather to have been due in part to exceptional care in the man-
agement and in part to a rapid gidn in wealth and population
in the community supplied. Its growth has been steady through
a long aeries of years and not excessive in any single year. Its
existence thus appears to be dUe in part to causes over which
the company has had no control and for which it is entitled to
no particular crecfit. Accumulated, as it has been, out of profits
m the performfmce of a public service, its existence aCFords ex-
ceptionat facilities and imposes peculiar duties upon the corpora-
tion in its relaition to the pubHc.
As the company has applied this surplus to the cost of im-
proving- and enlaiging its plant as has been needed to satisfy
the public demand, the property in which it has been invested
must otherwise have been represented by new capital contrib-
uted by the shareholders. Such use of surplus may properly
be nuule of substantial benefit to the consumers and share-
holders alike: to the former, by relieving them of some portion
of the burden which the investment of fresh capital necessarily
imposes, by affording the most ready facility for minor cfxten-
sions of the company's lines, fbr superior excellence in its
product and by aiding to the most satisfactory performance of
its varied duties toward the public; to the latter, by strengthen-
ing the corporation in eidiancing the security of ihe original
investments of the shareholders, and in bringing to them a re-
turn somewhat higher than that to which they might otherwise
be entitled. Such a surplus is by every principle of law the
property of the corporation. It has an undoubted legal right to
Digitized by VjOOQ iC
180 Valuation R 201
distribute it as a dividend as it is acquired, or pro rata to its
shareholders in case of liquidation; but, notwithstanding this,
the circumstances attending its accumulation impose upon the
company, so long as it continues to exercise the functions of a
public monopoly, the duty to employ it for the joint advantage
of the consumers and the corporation. It need not be dealt with
as the exclusive property of either.
Fortunately, in the majority of companies of this class in this
State, the recognition of this duty by the directors has been a
part of the policy of their management; until recently this has
been true also of the company in Haverhill. Now, however, its
policy appears to have undergone a very decided change.
The company brought an action in the Circuit Court of
the United States to restrain the enforcement of the Com-
mission's order reducing the price to eighty cents. The case
dragged along for many years and was finally compromised.
Another petition asking for a reduction in the price
charged by the Haverhill Company is now before the
Commission, and the decision will doubtless hinge largely
on the treatment of property constructed out of surplus.
Under the Massachusetts system of regulation, there is an
argument in favor of the consmner's eqmty in the surplus
which probably could not be so effectively used in other
states. The laws have since 1894 prevented a capitalization
of property constructed out of surplus and have required
the sale of new shares at approximately the market value.
And with the supervision over rates exercised by the legis-
lature and the state commissions, it seems probable that if
a company, such as the Haverhill Gas Light Company, had
attempted to pay out all its profits in dividends instead of
using surplus profits for betterme^ts, the legislature or the
state cqnunission would soon have reduced its rates.
§201. Pennsylvania Supreme Court in Brymer v. Water
Companyi 1897.
In Brymer v. Butler Water Company, 179 Pa. 231, 36
Digitized by VjOOQ iC
§202] Invested Surplus 181
Atl. 249, 251, decided January 4, 1897, it is held that
additions constructed out of surplus earnings are entitled
to a fair return. Judge Williams says:
In determining the amount of the investment by the stock-
holders, it can make no difference that money earned by the
corporation, and in a position to be distributed by a dividend
among its stockholders, was used to pay for improvements
and stock issued in lieu of cash to the stockholders. It is
not necessary that the money should first be paid to the stock-
holder and then returned by him in payment for new stock
issued to him. The net earnings, in equity, belonged to him,
and stock issued to him in lieu of the money so used that be-
longed to him was issued for value, and represents an actual
investment by the holder.
§ 202. Maine Water Plant Condemnation Case, 1902.
In the case of Kennebec Water District v. City of Water-
ville, 97 Me. 186, 54 AtU 6, 17, decided December 27,
1902, the Supreme Judicial Coiui; of Maine lays down
rules to govern appraisers in making the valuation of
property of the Maine Water Company for purposes of
purchase by the Kennebec Water District.' Judge
Savage in his opinion says (at page 17) :
Haintifi's request 13 asks that, if it be found that the com-
panies have actually received more than reasonable rates for
the services rendered since operations began, then the amount
of such excess shall be deducted from the amount to which
the companies would otherwise be entitled. It is not approved.
It is sufficient to say that this is not a process of accounting,
but one of condemnation of property, for which the owner
' The ocNirt while complying with the pioviaioDS of a state statute pro-
viding for such purchase, appreciates the possible diflSculties if not dan-
tjsn in attempting to fonnulate rules which are to be applied to facts not
yet ascertained. This is the first of two similar cases, the second one being
that of the Brunswick Water District, decided in 1904.
Digitized by VjOOQ IC
182 Valuation [§2Q3
18 entitled l;»y statute and constitution to just oompensation
at its present value, without any deduction.
As noted below in $ 795, Judge Savage held the eiioess
earnings of earlier years could nevertheless be considered
in fixing the present fair rate of return.
{908. Intenitate Commmce Cinmisaion im S^oktayb w.
Hortlieni Paci&Cy U09.
In Spokane t;. Northern Pacific Railway ComfMrny, 15
I. C. C. R. 376, 415, decided February 9, 1909, the Inter-
state Commerce Commission states that in detenmning
what will be reasonable rates for the future, tiie Com-
mission may properly consider that under the rates in
effect a large surplus has been accumulated in the past,
but that it should not make rates for the purpose of dis-
tributing such suigplus to the public. Comaiissioner
Prouty writing the opinion in this case says:
We come now to the complainants' claim that the surplus
which has been accumulated by these defendants from earnings
should be first subtracted from the value of their properties
in detennining the amount upon which they may properly earn.
The contention of counsel is that this surplus is a fund iield
by the railway company as trustee for the public, which this
Commission should in some way manage to redistribute to
the public in the establishment of just and reasonable rates.
The railway is certainly an agent of the Government in the
construction and operation of its property, and it is only al-
lowed to charge for its services a reasonable oompensation.
Does it from this follow that the surplus of the Great North-
em Railway, for example, which is said to be $70^000,000,
is held by that company in trust for the public? Does it ik>l-
low, even, that the value of this property to-day should be
decreased by $70,000,000 upon the theory that Hie public
has paid into the property that amount?
It is well understood that rates by all lines .to Spokane from a
given eastern destination must be the same. We have already
Digitized by VjOOQ IC
§ 203] iNVEfitED SuBPLUfl 183
held that in establiahing a jeasonable rate the strongest line
should not alone be considered; the necessities of the weaker
line myst also be taken into account. In the application of
this principle it is eyident that a rate might be fixed which
would pay a very moderate return by one line and a very hand-
some return by the other. Under the operation of these rates
the Gteat Nortbeni) by ^veasoii .of 'its .cheaper copstruction
and its easier operation, might accumulate a surplus while the
North^n Pacific did not. If so, oould it be said that the sur-
plus of the Great Northern bad been improperly accumulated
when its rates had been just and reasonable? Does the mere
fact of the accumulation of a surplus by a particular road
show that the rates upon that road have been excessive?
But assume that they have been. This $70,000,000 to
which the complainants refer in case of the Great Northern
surplus is the result of the operations of the Manitoba and
the Great Northern companies since the year 1880; that is,
for twenty-seven years. During all that period this surplus
has been gradually accumulated and has gone into the prop-
erty. Should the Government to*day take note of that sur-
plus for the puqx)8e either of so reducing the rates of the
company that no earnings can be made upon this much of the
property or with a view to in some sense turn that surplus
back agwi.into the hands of the public?
There is no absolute test of a reasonable rate, apd the Gov-
ernment has supplied none. During all this period the excess
has gone into the property, which has gradually become more
valuable, and this increased value has reflected itself in the
market price of the securities of that company. It is impos-
sible to restore what has been improperly taken in the way of
excessive rates to those persons from whom it has been re-
ceived. The Government, imder those circumstances, can not
lay hold on this surplus as a fund held in trust for the public.
This case strongly illustrates the fact that if any Govern-
ment tribunal is to do justice between the railway and the pub-
lic, if it is to feel any confidence in the correctness of its con-
clusions, its supervision must be continuous and not spasmodic.
There must be some point of departure and from that point
Digitized by VjOOQ IC
184 Valuation [§ 204
the knowledge of the Govemment must be accurate and com-
plete. After earnings have once been ''capitalized" and ben-
efits have been "conferred," when the various interdepen-
dent organizations have been perfected, it is impossible to
either know or to undo.
§ 204. Right to a rate of return adequate to construct better-
ments.
In certain rate cases it has been asserted that the public
utility should in addition to a fair rate of return be allowed
to accumulate suf&cient surplus earnings to construct
needed betterments. This is primarily a question of rate
of return and not of valuation but it necfessarily leads to
the question of whether if this is done the investors are
entitled to a retiun on the value of betterments thus con-
structed. This would be clearly absurd. But the advo-
cates in rate cases of the necessity of providing for better-
ments out of earnings do not propose any plan by which
betterments thus constructed will be separated from the
capital furnished by the owners and upon which they are
entitled to a fair return. The right to earn a surplus for
the construction of improvements and extensions was
persistently contended for in the two cases involving
general advances in railroad rates in 1911. In Advances
in Rates, Eastern Case, 20 I. C. C. R. 243, 265, decided
February 22, 1911, Interstate Commerce Conunissioner
Prouty discussed this question as follows:
It is contended by the defendants, and this is one of the most
important questions before us, that rates should be sufficient
to enable them not only to pay their current operating expenses,
their fixed charges, a reasonable dividend, and to maintain
their properties at the present state of efficiency, but also
to make improvements and additions to those properties of
a permanent character. Those who oppose an increase in
these rates answer that improvements of this character which
add to the permanent value of the property ought not to be
Digitized by VjOOQ IC
§204] Invested Surplus 186
paid from the current returns of the railroad, but should rather
be made out of new capital, and they point to the previous
decisions of this Commission and to the approval of those
decisions by the Supreme C!ourt of the United States as con-
firming that position.
In Central Yellow Pine Asso. v. I. C. R. R. Co., 10 I. C. C.
Rep. 505, this Commission had before it an advance in the rate
on yellow-pine lumber from points of production in the south to
the Ohio River. This advance was justified by the carriers
upon the plea that owing to increased cost of operation their
net returns were insufficient. In examining this matter the
Commission found that the carriers had charged as a part of
their operating expenses large siuns, which had, in fact, been
devoted to the purchase of new equipment and to the making
of permanent improvements to their roadway and structures,
and held that these items were not properly chargeable as
operating expenses, for the reason that the shipper of to-day
could not be properly required to pay the entire cost of an
improvement or addition which was to be of permanent use.
The opinion was expressed that sufficient net returns would
appear if these items of permanent expense had not been in-
cluded in the cost of operation.
Suit was brought to enforce the order of the Commission
that the carriers desist from this advance, and in the Supreme
Court, Illinois Central R. R. Co. v. I. C. C, 206 U. S. 441, the
railroads contended that this holding was manifestly errone-
ous, citmg Union Pacific R. R. Co. v. U. S., 99 U. S. 402. The
court, however, fully sustained the Commission, distinguishing
that case from the one at bar. . . .
The president of the Pennsylvania Company testified that
ance 1887 his company had put into the Pennsylvania lines
east of Pittsburg $282,000,000 from earnings. During all
that time this company has also paid to its stockholders mu-
nificent dividends. Now, to whom belongs this $262,000,000, a
sum which, according to the statistical report of the Pennsyl-
vania Railroad Company to this Conmdssion for the year
ending June 30, 1910, equals nearly two-thirds of the total
cost of construction of the 2,123 miles owned by that company?
Digiti2ed by VjOOQ IC
186 Valuation [§ 205
Suppose this Commission were required to fix a value upon
the Pennsylvania lines east of Kttsburg. Could any distinc-
tion be made between this sum which has accrued from the
operation of the property and what has been paid in from other
sources? . . .
It is evident that until the status of this surplus is determined
by legislative action or judicial interpretation, this Commission
can not properly permit an advance in rates with the intent to
produce an accumulation of surplus for this purpose.
It is also said that railroads should be allowed to accumulate a
surplus for the purpose of providing, for the time being, for the
interest charge on new capital, which represents an improve-
ment which is necessary, and which will finally be profitable,
but which does not pay an immediate return.
To this claim within certain Umits we assent. In the develop-
ment of a railroad it must often invest money in permanent
structures like a passenger station, which will not add for the
time being to its revenues, although it may do so finally. It
is reasonable to say that such rates may be charged as will
permit the accimiulation of a fund to take care of cases of this
sort. But to this surplus fund stockholders should be required
to contribute by reasonable reduction in dividends. If such
a system of financing is to be adopted as will render the pay-
ment of dividends upon common stock as certain as those
upon preferred stock, then the dividends to the holder of the
common stock should be no larger.
This same subject is considered in the opinion of C!om-
missioner Lane in the Western Case decided the same day
as the above.**
§ 205. Betterments out of eaminge— New York Public Serv-
ice Commission, 1911.
Re Queensborough Gas and Electric light Company,
2 P. S. C. 1st D. (N. Y.), decided June 23, 1911, involves
^Advance in Rates, Western Case, 20 1. C. C. R. 307, 333, 336, decided
February 22, 1911.
Digitized by VjOOQ IC
f -206] IifvaBTSD Sdbplus 187
a valuation lor rate purpoaeB. Commissicmer Maltbie in
delivering the opinion of the Commission says:
Furthermore, it is not reasonable to require consumers to
pay higher rates than they otherwise would be required to
pay in order that these higher rates may provide funds from
which to construct additional plant, which becomes the prop-
erty of the company. Such plant and property is ordinarily
paid for out of capital, but whether this course is followed or
the stockholders voluntarily relinquish a share of their divi-
dends in order to increase the value of their property, has
no relation to this case. Suffice it to say that the consumer
should not be required to pay higher rates and thereby make
a donation to the company or to its stockholders.
§906. Betterments otft df earnings — ^American Telephone
and Telegraph Company, 1912.
The report of the direotors of the American Telephone
and Telegraph Company, March 20, 1912, contains a
statement of the reasons why it is desirable to make
betterments out of earnings and to maintain liberal re-
serve funds. In doing so the directors accept the logical
conclusion that such reserves and betterments shall not be
used in the future to pay increased dividends to the stock-
holders but shall constitute a trust to be administered in
the public interest. The frank acknowledgment of this
obligation is an unusual feature in the demands that are
being made for a return adequate to construct .ne^ed
betterments out of earnings. The directors say (at pages
8-12):
Tbe main objections urged against an accumulating surplus
are the following:
1. That it is provided out of excessive charges to the public
ior service.
2. That it tends to extravagance of operation, on the theory
that doae margins tend to greater economies.
3. That it a£fords a way of giving exorbitant and unreason-
Digitized by VjOOQ IC
188 Valuation [§ 206
able dividends to the shareholders by some form of distribution
of the surplus from time to time.
The answer to the third objection depends somewhat on the
treatment and ultimate disposition of the unappropriated sur-
plus reserves.
If these reserves are to remain as assets of the company, in-
divisible, inviolable and inalienable except for the purposes above
. mentioned, invested in productive property, it removes the
strongest and only really tangible objection to surplus of the
character herein advocated.
So far as the American Telephone and Telegraph Company
and associated controlled companies are concerned, the third
objection can be dismissed with the statement of their policy,
which is as follows:
Except where in the extension of business extraordinary
risks are taken which entitle them to some extra profit in con-
sideration of such risks, or the net returns have not been suffi-
cient to make an adequate return, if any, on the capital, the
American Telephone and Telegraph Company and associated
utilities controlled by it are and will be satisfied with reasonable
average returns on their outstanding capital obligations, which
compared with other business investments should be about
8 per cent., and will not expect or encourage any expectation of
more than this; and in those excepted instances above referred
to, they will only ask for that reasonable return which any
equitable commission or court would award them.
As te the second objection. The most important and con-
trolling factors of all charges for service are fixed charges and
operating expenses. AU public service, companies not now, will
soon be under government control and regulation, and all
charges and expenditures will be under the close scrutiny of
these regularly constituted bodies. If this does not protect
against extravagance, nothing will.
In answer to the first objection, the many and marked pe-
culiarities of the telephone and telegraph as distinguished from
other public utilities justify ample surplus reserves. . . .
Among the more important advantages to a company of a
large surplus represented in the fixed assets are the following:
Digitized by VjOOQ IC
V
§206] Invested Surplus 189
It strengthens the company's credit, enabling the company
to make its interest and dividend payments miiform and de-
pendable.
It enables the company on the strength of this credit to ob-
tain its capital requirements on the most favorable terms.
It enables the company to ride out commercial and financial
disturbances which might otherwise cripple or destroy it.
It enables the company to maintain at all times the highest
state of efficiency in its operation, which would be impossible
for any company which is obliged to adjust its more or less in-
flexible operating expenses to the constant and inevitable fluc-
tuations of business.
It is a reservoir, as it were, which, supplied by a fluctuating
stream of gross revenue, enables the company to maintain even
and imiform disbursement for ser\dce, maintain a uniform
operating organization, and that high state of efficiency which
can result only from a permanent operating; forx^e.
To reduce rates as fast as any surplus is created^ to forbid any
application of revenue to the betterment of plant, to insist that
new capital shall be provided for such purposes, would never be
thought of in any private business i^d should not in any cor-
porate business, particularly public utilities, subject to other
regulation and control than that of actual ownership. In in-
dividual or partnership business all revenue beyond stipulated
amounts is left in the business, is a reserve, and in addition
there is that resetve consisting of the entire assets of the indi-
vidual. This is the basis of business credits.
The only sound ccmclusion that can be reached after full con-
sideration of all the various phases and factors of the problem
is, that amfde reserves should be provided to meet not only
probable happenings but possible happenings, and that such
reserves should be so invested that whatever increment or
revenue is to be derived from the amounts unexpended or not
used for the purposes intended will go to the public in reduction
of chaises for or in improvement of, service, and that the value
of a public utility plant should be represented by a relatively
small percentage of outstanding securities calling for fixed
charges.
Digitized by VjOOQ IC
CHAPTER X
Uinised Ptopertj
§ 210. Discarded property.
211. Discarded property — Wisconsin Railroad Commission.
212. Inclusion of river intake and fifter galleries, Wisconsin.
213. I^scarded property — Des Moines Gas Rate Case, 1896.
214. Land' acquired in advance of present need — New York PubBe
Service Conunission.
21&. Land— San Fmncisoo Water Rate Case, 1906-1911.
216. Ebccessive investment in plant.
217. Excessive investment — New Jersey Chancery Court, 1906.
§ 210. Discarded property.
Usually in any large public utiKty enterprise tkat has
been in operation for a considerable time there are various
items of discarded property. A certain station site has
. been abandoned and is being held until it can be disposed
of to good advantage. A car has been discarded but has
not actually been sent to the scrap heap. The Wisconsin
law provides that the commission shall value property
''used and useful for the convenience of the public." This
is a good statement of the principle, whether the viduation
is for rate purposes or for purposes of public purchase.
Property that has been discarded and is no longer " used
or useful for the convenience of the public " should not be
included. Though the principle is clear it is rather difr
cult of application. A certain degree of use may be
claimed for any piece of property. A valuable lot may be
used for storage. An old car may be used in an emergency.
In so far as such claims are true they must be allowed for.
The value allowed, however, should not be based on cost
of reproduction but on the actual value to the company of
the service rendered. A valuable lot used for storage
1 1901
Digitized by CjOOQIC
§211] Discarded Property 191
purposes when a cheai)er lot would answer the purpose
should be included at the value of the cheaper lot. A
power plant not used but held for a possible emergency
should be included at the value of such emergency service.
S 211. Discarded property— ^sconsin Railroad Commission.
In the LaCrosse Gas and Electric Company Case, 8
W. R. C. R. 138, 164, decided November 17, 1911, the
Wisconsin Railroad Commission holds that when unused
property may be disposed of without affecting the busi-
ness, the only warrant for its retention is expected savings
and additional net income. This being the case, an addi-
tion to the phjrsical value of the plant for non-operating
property can be justified for rate-making purposes only
when the income expected therefrom is added to the actual
income or is deducted from the operating expenses. The
Conmoission says (at page 164) :
No evidence was furnished that shows that anything in-
cluded in table II is required for the operation of the appli-
cant's plants. While it is claimed by the applicant that cer-
tain items, especially the ammonia concentrator, may be used
in the near future, we do not find that the present business
nor its immediate prospective growth would in any way be
materially affected by the disposal of this equipment. If the
ammonia concentrators are retained by the company and are
operated at some future time, then the saving or profit that
may be derived therefrom should offset the interest, deprecia-
tion and operating costs of the same. When such non-operating
property is held by a utility, the only warrant for its reten-
tion is expected savings and additional net income. This
being the case, an addition to the physical value of the
plant for non-operating property can be justified for rate-making
purposes only when the income expected therefrom is added
to the actual income or is deducted from the operating ex-
penses. Therefore, whether or not this non-operating equipment
may profitably be kept on hand, is a matter which need not
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192 Valuation [§ 212
be passed upon for the purposes of this case; the relative econ-
omy of holding non-operating property as agidnst purchases
at such time as the equipment in question may be needed, is
a matter concerning which the management must use its own
judgment. The simplest equitable method would be, it seems,
not to consider these investments in the determination of rates.
In the case of the application of Darlington Electric Light
and Water Power Company, 5 W. R. C. R. 397, decided
June 17, 1910, involving the valuation of an electric light
and power plant for rate purposes the Commission held
as follows: ^
Where equipment not actually part of the producing plant
has been retained and serves as an emergency or reserve unit,
it is properly included as property used and useful in serving
the public. Equipment, however, which has been cast aside
for larger units, more adapted to the present use of the plant,
or which has been abandoned as impracticable, cannot be in-
cluded as a part of the valuation servmg as a basis for adjust-
ment of rates.
The case of City of Appleton v. Appleton Water Works
Cpmpany, 5 W. R. C. R. 215, 240, decided May 14, 1910,
involves the valuation of a water plant for rate purposes.
The Commission says:
The wells in question appeared to have been the original
source of water supply for respondent's plant, but their use
seems to have been discontinued when the river intake, filters
and reservoir were added to the plant. As these wells are no
longer used or useful for service, they must be eliminated from
the valuation. The statute limits the scope of the investiga-
tion to ascertaining the value of the active property of the
utiUty.
§ 212. Inclusion of river intake and filter galleries, Wisconsin.
Re Manitowoc Water Works Company, 7 W. R. C. R.
> For a discussion of this general problem, see also City of Beloit v.
Bdoit Water, Gas and Electric Co., 7 W. R. C. R. 187, 234, July 19, 1911.
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{ 21^ Discarded Propebtt 19S
71, 80, decided June 27, 1911, involves the valuation of a
water plant for purposes of municipal purdbase. The city
objected to the inclusion of the value of the river intake
as inadequate for the purpose intended and at present
neither used nor useful. The Commission, however, in-
cluded the intake in the valuation. The Commission
says (at page 80):
The company was required and compelled by the city to
build this mtake. From the point of view of fire protection
its construction was also a step in the right direction.
It further appears that the city built or authorized to be built
the sewers which empty into the river above the river intake. In
short, while compelling the company to build the intake, the
city seems to have made no effort to protect the water above
it from becoming contaminated and ttom rendering the use
of the intake a menace to the public health. The presence
of the sewer outlets and the consequent pollution of the river
water is a matter over which the company had no control and
for which it is in no way responsible.
As a matter of simple justice it would hardly seem fair to
deprive the company of the value of property which it in-
stalled at the order of the city and which the city failed to
protect and rendered valueless by its own actions. In other
words, if the intake is of comparatively little value to-day,
it is so because of conditions for which the city is in a large
measure responsible. To entirely exclude it from the valuation
would, for these reasons, hardly seem fair.
In this same case the city objected to including the value
of filter galleries, claiming that these galleries were not a
necessary and useful part of the equipment of the plant.
Hie CoBunission sajrs (at page 79) :
Some effort was made by tiie city to have the value of the
galleries excluded from ihe valuation of tiie plant, on the
grounds that they were not useful or valuable as a part of the
system. It appears that the original plans called for the con-
13 ,
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194 Valxtation [§213
fitruction of these galleries as the water producing feature of
the plant. It appears further that the galleries failed as a source
of supply and that they have dnce been used as storage reser-
voirs.
As a means of storing water these galleries appear to be used
and useful as a part of the plant. Furthermore, as previously
described, these galleries constituted a part of the experimen-
tal work conducted to seciu^ a source of supply, and it would
seem that the cost of the galleries should be a Intimate chaige
to the construction or a part of the investment necea^tated
in the building of the system. In view of these facts it seems
only just that the cost of these galleries should receive con-
sideration herein. In the light of the investigations made, it
is believed that the stafif's figures should stand.
§213. Discarded pioperty—Des Moines Gas Rate Case,
1896.
In Capital City Gaslight Company v. City of Des
Moines, 72 Fed. 829, 844, decided January 8, 1896, the
court says:
Defendant insists that a part of the present gas plant is
not only unnecessary for present use in supplying gas in Des
Moines, but also for probable use in the near future, and that
that part of the plant devoted to manufacture of coal gas
should not be included in any computation for determining
the money value, or in any bads used for determining on what
plaintiff may rightfully ask income or profits. The fact that
plaintiff has at Des Moines, in operation, two distinct or
separate parts of its gas plant, — one for manufacturing coal
gas, the other for water gas, — ^has served to increase greatly
the difficulties attending a decision of this matter. If I re-
member rightly, all the witnesses agree that, the coal-gas
plant having been erected and being on the plaintiff's ground,
they would not recommend its destruction. There exists a
marked difference of opinion among the experts as to whether,
if erecting a new plant, they would advise such coal-gas plant
to be included as a part of it. The trend of proof is to the
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§ 214] Unused Land 105
effect that the later-built plants are almost exclusively for
the manufacture of water gas. But on this point I am not
satisfied that it would be improper to include the coal-gas
plant, and therefore, for present hearing, retain it as a part
of the property to be considered in our calculations as to
rates. But its retention complicates the decision herein, for
there is thus retained an element whose exclusion would take
with it many obstinate and preplexing questions. Returning
to the attempt to ascertain the cost of present reproduction
of plaintifTs gas plant, or rather of a gas plant which shall be
equally efficient and capable in supplying gas to the defend-
ant and its citizens, and examining the proof for that purpose
as introduced by plaintiff and defendant, I conclude that suit-
able and proper real estate could be obtained, and such plant
erected, mains laid, etc., with same efficiency to meet demands
of the city as that now possessed by plaintiff, for $400,000.
The experts sworn on plaintiff's behalf have varied in their
figures from about $450,000 to about $500,000. From these
estimates must be taken that part of the present plant which
was used for fuel gas, and is now not available for present use^
also, the overestimate by them made on the real estate; and
also making allowance for storage capacity on the holder last
erected beyond what seems, imder present circumstances,
profitably necessary. On the whole proof, I reach the con-
clusion above announced.
S 214. Land acquired in advance of present need— New York
Public Service Commission.
An exceptionally clear and illuminating discussion of
the treatment of land acquired in advance of present need
is contained in the opinion of Commissioner Maltbie in
the case of Mayhew v. Kings County Lighting Company,
2 P. S. C. 1st D. (N. Y.) — , decided October 20, 1911.
This is a rate case. Commissioner Maltbie applies the
general theory first worked out by him in the Queens
Borough Gas and Electric Light Case, 2 P. S. C. 1st D.
(N. Y.) — , decided June 23, 1911, in regard to the treat-
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196 Valuation [§ 214
ment of appreciation in land value as income, and this
very greatly simplifies the problem of land acquired in
advance of present needs. He says:
As to the amount of land which should be appraised at a
fair value, two solutions may be suggested. One cause for the
appraisal of the land that is actually needed at the present time,
leaving the company free to carry additional land, or to make
no such provision, as it chooses. If this solution were followed
and if the company did purchase land that was not needed, any
profit or loss which would thereby arise would not be a factor
to be ccMisidered in a rate case. The company would be en-
titled, however, to earn a fair return from some source upon
the fair value of the land actually and necessarily used.
The other method requires the appraisal of all land whether
used for gas purposes, held in reserve or purchased for other
reasons. If this plan were followed, the income from all land,
wheth^ through the sale of gas, rentals or the increase in value
from year to year, would be a part of the income of the com-
pany and considered in determining the rate to be charged
for gas.
Prudent management may require that land shall be pur-
chased in advance of actual needs, for it may be clearly im-
possible to secure adjacent property just as it is needed at
reasonable terms. Upon the other hand, it would be unwise for
the Conmiission to adopt a policy that would encourage a com-
pany to speculate in land ad infiniium and to call upon the gas
consumers to pay its losses. Even if they were to share in the
profits, it would be unwise, for the purpose of a gas corporation
is not ^)eculation in land, but to supply gas to consumers. The
distribution of gas is a quasi-public function, and for this reason
gas corporations have been given imusual powers. Speculation
in land is not such a function. But if a company does acquire
more than is immediately necessary, and if such acquisition is
reasonable and wise, the consumers, who, under such circum-
stances, must carry the burden, should also share whatever
gains may accrue from such ownership. It is the opinion of the
Commission that a company should be allowed reasonable lat-
Digitized by VjOOQ IC
$215] Unused Land W
itude, that it should not be penalised for purchasing land some-
what in adyanoe of its needs and that the resulting revenue or
profit, being a necessary adjunct of the distribution of gas to
the extent that the property itself is a part of the gas property,
shall be considered part of the income of the company.
Applying these principles to the facts in this case, it is clear
that the land which is not used even in part for gas purposes
should be excluded from consideration; it should not be included
among the property upon which a fair retiun is to be earned,
and the income therefrom should not be treated as part of the
income of the company for the purposes of this case. Probably
the other parcels contain more land than is needed. However,
if these be included in their entirety in "fair value," and if all
rentals, increase in value and other income therefrom be placed
in the income account, the result will not vary materially from
that obtained from the strict application of the above principles.
In view of this fact, and the fact that fewer complications are
encountered in applying this plan, the simpler method has been
followed in this case.
§ 216. Land— £an Francisco Water Rate Case, 1908-1911.
In the case of Spring Valley Water Co. v, San Francisco,
165 Fed. 667, 697, decided October 7, 1908, District Judge
Farrington said:
It is not just to compel consumers to pay for more than they
receive, or to pay complainant an income on property which
is not actually being used in gathering and furnishing water.
If in this case the company, in anticipation of the |pt)wth of
the city and its future needs, acquired property tof future
use at a cost of hundreds of thousands of dollars which is
now worth millions, it has acted wisely, but it should be sat-
isfied with the goodness of its bargain and the enhanced value
of its prop>erty, without asking in addition gratuities from
its customers in the way of higher rates. When the property
does come into necessary service, the company is entitled to
have it credited at its then fair and reasonable value for rate-
fixing purposes.
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Ids VALtjAWOii K216
As a result of the above hearing a prelimmary injunction
was granted against the enforcement of the ordinance
of fixing water rates. The same judge in 1911 made the
injunction permanent and in the valuation approved these
unused lands and water rights were again excluded.*
§ 216. Excessive investment in plant
Every plant when constructed is designed to meet the
requirements of a number of years growth. Every im-
provement and extension is designed with the same pur-
pose. This is a rudimentary principle of economical con-
struction. Unless growth is adequately provided for, the
loss from inadequacy will be enormous. In a starting
plant the necessity for a much larger investment than that
required to take care of immediate business is one of the
chief causes of low returns during the first years. This
is sometimes referred to as the cost of establishing the
business (see below, § 636). It is not considered wise or
practicable to fix rates so high that the enterprise will pay
a fair return on the entire investment from the start. It
is believed that with increased business the reduced per
unit cost will permit the investors to make up for the low
retiuns of the first few years. In any live plant there
must always be room for growth — ^always capacity to
take on more business. The investment necessary to se-
cure this surplus capacity is a reasonable part of the
present cost of service.
The case of Des Moines Water Company v. City of Des
Moines involves the valuation of a water plant for rate
purposes. The master in his report of September 16, 1910,
says:*
* Spring Valley Water Worioa v. San Francisco, 192 Fed. 137, October 21,
1911.
' Des Moines Water Co. v. City of Des Moines, No. 2468, in equity.
United States Circuit Court, Iowa Southern District, Central Division,
Report of George F. Henry, Master in Chanceiy, filed September 16, 1910.
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§216] ExcEssivB hrvEMvcENT 199
In asoertainmg this actual or reproductive value, the com-
pany has the right to anticipate the growth of its business
and to be allowed a proper return on a plant of sufficient ca-
pacity for such growth.
Sometimes, however, expectations in regard to future
growth are not realized and the enterprise has been
saddled permanently with a much larger investment than
the business warrants. In such cases the consumer ought
not to be required to pay profits on capital thus unwisely
sunk. Under our theory of private ownership the investor
takes the responsibility of determining the amount and
character of investment. If he constructs a plant where
it is not needed or seriously misjudges futiu*e growth, he
should stand the loss. Considerations of this nature are
involved in the case of City of Racine v. Racine Gas Light
Company, 6 W. R. C. R. 228, 229, decided January 27,
1911. This case involved the valuation of a gas plant for
rate purposes. The engineers found after a thorough in-
vestigation that the plant was larger than the demands of
the business required and that the increased investment
did not for the most part result in more economical opera-
tion. Under these conditions it was held by the Wiscon-
sin Railroad Commission that the situation in this respect
is such that it is far from clear whether it would be equi-
table to all concerned to fix rates in this case, the receipts
from which would return interest and profit on the cost of
reproduction of the plant at as high rates as those which
mi^t ordinarily be regarded as adequate in cities of this
size.
In San Diego Land and Town Company v. Jasper, de-
cided April 6, 1903, the United States Supreme Court
clearly decides that excessive investment shall be ex-
cluded. Justice Holmes says: ^
«Sui Diego Land and Town Co. p. Jasper, 189 U. 8. 439, 446, 447,
28 Sup. Ct. 571, 47 L. ed. 892, April 6, 1903.
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200 Valuation [|217
If a plant is built, as probably this was, for a larger area
than it finds itself able to supply, or, apart from that, if it
does not, as yet, have the customars contemplated, neither
justice nor the Constitution requires that, say, two-thirds
of the contemplated niunber should pay a full Return. The
only ground for such a claim is the statute taken strictly ac-
cording to its letter. ... If the original company embarked
upon a great speculation which has not turned out as expected,
more modest valuations are a result to which it must make up
its mind.
§ 217. Bzcessive investmeat— New Jersey Chancery Court,
1906.
The case of the Long Branch Commission t^. Tintern
Manor Water Company, decided November, 1905, in-
volves the valuation of a water plant for rate purposes.
In this case the water plant had been constructed with a
view to the denoands of a fifty-year growth. The court
deducted $130,000 from a total cost of $1,400,000 in view
of the fact that certain portions of the plant were lai^er
or more expensive than was reasonably required. The
court does not hold, howev^, that the company is not en*
titled to- a return on an investment large enough to take
care of growth for a reasonable period. The oourt says: ^
It is admitted that the new works are supposed to be amply
sufficient, both as respects the supply of water and the size
of the principal mains, to supply the region within its reach
for 50 years to come. Indeed, the raae and costliness of the
plant is a matter of compliunt by the complainant, and it
insists that it should not be called upon or required to pay
rates for water sufficient to pay a fair return for so great an
expenditure. There is a measure of soundness and justice in
this contention. The inhabitants of the borough of Long
' Long Branch Commission v. Tintern Manor Water Co., 70 N. J. £q.
71, 62 Atl. 474, 477, 479, 480, November, 1905, Court of Chanoeiy of New
Jersey.
Digitized by VjOOQ IC
§217] Excessive Investment 201
Branch ought not to be compelled to pay water rates adjusted
to pay an mcome on a greater outlay in a plant than is rea-
sonably needed for its supply. . . • The supplying company
is, as we have seen, under obligation to keep in advance of
the present demand and take liberal account of the probable
increase of demand due to increase of population. . . . These
considerations lead to the conclusion that the water company
when it starts with new works, or a large addition to the orig-
inal mipply, is entitled to an income therefrom somewhat
greater than what is due to the cost of work sufficient merely
to meet the present demands. I say "somewhat greater" for
I do not mean to be understood as holding that capitalists
ought to expect an immediate compensatory income from an
enterprise of this character. But on the other hand it would
be manifestly unjust to expect them to invest their money in
a plant necessarily larger than present demands inquire and
take as income therefor such a sum as would satisfy an invest-
ment sufficient to meet present demands. For here comes
in again, with great force, the consideration previously men-
tioned, that the municipaUty cannot bind itself for more than
10 years; and, in fact, need not bind itself at all for any period,
and it holds in its hand the absolute power to oust the water
company at any time it shall so choose and may exercise that
power as soon as by the increase of population and demand,
the investment by the capitalists shall have become actually
profitable. This is one of the risks spoken of and provided
for by the Supreme Court oi Maine. . . . Defendant admits
that its plans were adapted to a future estimated growth of
50 years. Mr. Sherrerd says, and I agree with him, that 50
years is too long for a forecast. He fixed 30 years as the usual
linut.
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CHAPTER XI
Average Price v. Present Price
§ 230. Method followed by Wisconsin Railroad Commission.
231. Michigan and Minnesota railroad appraisals.
232. Rule that neither the highest nor lowest prices should govern.
233. Average price for period equal to construction period.
234. General considerations.
§ 230. Method followed by Wisconsin Railroad Commission.
The general method followed in the appraisals of the
Wisconsin Railroad Conunission is described by Prof.
Wm. D. Pence, Engineer to the Wisconsin Railroad
Commission and Wisconsin Tax Commission, as follows
(at page 51) : ^
In order to avoid extreme variations in unit prices due to
the fluctuations in market quotations and also with a view to
approximate as closely as practicable the conditions which
usually prevail in building up public utiUties properties, it has
been the practice of the staff to use average prices for a term
of years rather than to apply the current quotations or unit
costs prevailing at ihe actual date of inventory. For this
purpose the average price for the five-year period immedi-
ately preceding the date of valuation has been used whenever
in the judgment of the staff such rule was practicable.
The Wisconsin Conmoission discussed this matter at con-
siderable length in Hill v. Antigo Water Company, 3 W.
R. C. R. 623, 639, 640, decided August 3, 1909:
While there is thus a great deal to be said in favor of using
current prices in determining the cost of reproduction new
^ "Woric of the joint engineering staff of the Wisconsin Tax and Rail-
road Commission/' by Wm. D. Pence, in Engineering Record, Vol. 59,
pp. 10, 49, 73, January 2, 0, 16, 1909.
[202]
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and the present value of the plant, it would seem to be clear
that what has thus been said would apply with greater force
when the plants are valued for the purposes of being taken
over by the municipality, than when privately owned plants
are valued for rate-making purposes. Rates based upon val-
uations that rest on current prices, would necessarily have
to be changed with all changes in these prices. . • •
In order to secure the greatest possible permanency in the
rates, it is necessary that the valuation upon which tiiey rest
should be subject to the fewest possible fluctuations. This
desired stability in the valuation can usually be obtained by
carefully computing it upon the average prices for a term of
years of the various factors that enter into the plant. Just
how long a period should be chosen for this purpose cannot be
stated offhand. But a little investigation will readily disclose
the usual or normal price in each case.
In City of Appleton v. Appleton Water Works Company,
5 W. R. C. R. 215, 229, decided May 14, 1910, the Com-
mission says:
If the standard by which the reasonableness of charges is to be
determined should fluctuate with the market prices of material,
labor and land, no schedule of Vates could be established for
any length of time, for, under the circumstances, a rate that
would be reasonable to-day might be very unreasonable to-
morrow. The principles of the law applicable to the subject
certainly involve no such absurd consequences.
In this case the Conmoission includes an extended state-
ment from its engineers as to the basis they have used in
determining unit prices. This statement contains a chart
showing fluctuations in prices of cast iron water pipe and
a comparison of monthly prices with one year, five year
and ten year averages. The above were both rate cases
but in 1911 the same principle is applied to the valuation
of a water plant for purposes of municipal purchase. Re
Manitowoc Water Works Company, 7 W. R. C. R. 71, 86,
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204 Valuation (§ 231
decided June 27, 1911. The following is from the decisicm
of the Commission:
Whether the prices should he based on a ten year average,
five year, two year, or one year average, may properly be a
matter for consideration and will perhaps be open to argument,
but in view of facts as regards the variation of current prices
from month to month, it does not appear just or reasonable to
allow current prices to govern in the determination of value,
either for the purpose of sale or rate making. Based oii a one
year or upon a two year average basis, it appears that the unit
price will be lower in this case than when the five year average
is used. This fact should, perhaps, be given weight in arriv-
ing at the valuation considered herein.
§ 231. Michigan and Minnesota railroad appraisals.
In the Michigan railroad appraisal of 1900 and 1902,
the unit prices used were fixed by determining the average
price for a term of years, usually five. This appraisal was
for tax purposes. Henry Earle Riggs, an engineer con-
nected with the Michigan appraisal, in his paper on
Valuation before the American Society of Civil Engi-
neers, says: *
As a basis, the average of either 5 or 10 years should be used
in preference to current prices on all such material and equip-
ment 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 it would appear to be proper to use
current prices. There can be no hard-and-fast rule which will
* In ProoeedingB American Society of Civil Engineeni^ November, 1910,
p. 1506.
Digitized by VjOOQ IC
f 232] Unit Pbiges 205
be applicable to all appraisals. The unit prices must be such
reasonable figures as can be sustained in Court.
Dwight C. Morgan, engineer in charge of the Minnesota
raihx>ad appraisal of 1908, states that in this appraisal
the ''question was raised as to using average prices for
labor and materials for a five year period ; and in deference
to the wishes of the representatives of the railways, it was
agreed that the average prices prevailing for the year 1906
should be employed." He says that a review of prices for
the five year period ending June 30, 1907, shows that the
prices prevailing for the year 1905 are in most respects as
near the average for the five year period as practicable.'
This valuation was made by the Mixmesota Conmiission
with a view to its use for rate purposes.
§ 232. Rule that neither the highest nor lowest prices should
govern.
The Iowa Supreme Court in a gas rate case holds that
neither the highest nor the lowest prices should govern.
The court says: *
In estimating the value gI the cast-iron mains and pipes,
computation was made in behalf of the company at $32.50
per ton; a reduction being allowed from the price of Decem-
ber, 1906, of $5.50 per ton for depreciation. The record in-
dicates that the price taken was the highest at which mains
and pipes had ever sold, and that these ranged in previous
years down as low as $18 per ton. The pipes were not avail-
able for the market, and, in estimating their value in the ground,
the price of iron on the particular day the ordinance was en-
acted ought not to be seized upon as the criterion of value,
whether it were the highest or lowest price. No one in calcu-
* See Annual report, Minnesota Railroad and WarehouBe CommiAsion,
1906, p. 21.
« Cedar Rapids Gas Light Co. v. Cedar Rapids, 144 la. 426, 120 N. W.
966, 970, May 4, 1909; affirmed 223 U. 8. 655, March 11, 1912.
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206 Valuation [§ 233
lating on the value of a similar plant would adopt such a rule.
The cost of the pipe, the prices at which it ordinarily had
sold, in connection with present prices, should be considered
in connection with depreciation by inevitable decay.
In the appiraisals made by the New York Public Service
Commission for the First District the unit figures are
averages for several years where there, has been much
fluctuation in prices. Unless there is considerable fluctua-
tion, present prices are taken.
§ 233. Average price for period equal to construction period.
In the rules laid down by the Supreme Judicial Court of
Maine to govern appraisers in appraising a water plant for
puj*poses of condenmation it is stated that reproduction
cost shall be based on the normal or average price for a
period of years prior to the date of taking, corresponding
to the probable period of construction. Judge Savage
says:*
It is suggested that in fixing the value on January 1, 1904,
allowance must be made for the fact that a plant ready to be
delivered on a given date must have been conmienced a con-
siderable time before, certainly. When we say "present prices"
we mean prices within a period necessary for construction.
Henry L. Gray, Engineer to the Railroad Conunission of
Washington, in describing an appraisal of the Seattle
Telephone Companies, discusses the question of the use
of average price or prevailing price: •
In preparing such appraisals, it has frequently been the
custom to use the average of prices prevailing during several
years previous, this method being based upon the assmnp-
tion that the number of years selected would cover the con-
• Brunswick and T. Water District v, Maine Water Co., 99 Me. 371,
59 Atl. 537, 542, December 14, 1904.
* In Engineering and Contracting, May 3, 1911, pp. 520, 521.
Digitized by VjOOQ IC
/
J
§ 234] Unit Prices 207
stniction period. The wisdom of so selecting' prices has not
been clearly demonstrated. If the plant is new, and actually
was constructed during the years selected, then the advantage
is obvious, but if the date of appraisal is remote from the date
of construction, why average a number of prices that bear no
relation to the actual cost, or the prevailing prices? It is equally
fair, and much more convenient to assume that the date of
the appraisal represents the beginning of the construction
period, rather than the end. It may be well said that the
past years exhibit the prevailing cost of work, while those of
the future do not. Nevertheless, it should be borne in mind
that practically all the material will be contracted for at the
beginning of the work, and that labor costs are not apt to
vary materially in three or four years. After all, the probable
construction period is an assumption, either way it is taken,
and the folly of splitting hairs over assumptions, and entail-
ing a great deal of additional work, should be evident, partic-
ularly'^ when it is remembered that the cost of reproduction
is only one element of the value.
§ 234. General considerations.
If it is desired to base fair value on the reproduction
method in its strictest form, present prices are doubtless
the more logical. If the problem is, what will it cost to-day
to replace the existing plant, the prices of to-day will
naturally be used. The theory that an average for a
period of years preceding equal to the assumed con-
struction period shall be used has difficulties, certain of
which have been pointed out above by Mr. Gray (§ 233).
Moreover, price movements are quite frequently in long
cycles and therefore present prices may be nearer the
average for the next few years than would be an average
based on the past few years. On the other hand it is clear
that a process of averaging by five or ten year periods
greatly reduces the fluctuation in price level. A curve
diowing monthly prices averaged annually is uneven,
while with each lengthening of the period to two years.
Digitized by VjOOQ IC
208 VixuATioN [§ 234
five years and ten years, the curve is smoothed but and
the variations from year to year correspondingly reduced.
This is brought out clearly by a chart published by the
Wisconsin Railroad Conmiission in City of Appleton v.
Appleton Water Works Company, 5 W, R. C. R. 216,
decided May 14, 1910. If the reproduction method is
used not as an end in itself but as a means of finding a
fair and equitable basis for determining the relations be-
tween the investor and the consumer, a modification re-
ducing the effect of price fluctuations is not inconsistent.
A five year average is good but in certain cases a ten year
average is probably better.
Digitized by VjOOQ iC
CHAPTER XII
Overhead Charges
{240. Introductory.
241. Appraisal of Chicago surface railways, 1906.
242. Appraisal of Chicago Consolidated Traction Company, 1910.
243. Appraisal of Chicago gas plant, 1911.
244. Cleveland street railway appraisal, 1909.
245. Columbus, Ohio, Electricity Rate Case, 1906.
246. Des Moines, Iowa, Water Rate Case, 1910.
247. Lincohi, Neb., Gas Rate Case, 1909.
248. Appraisal of street railways for Massachusetts Validation Board,
1911.
249. Appraisal of N. Y., N. H. & H. R. R. for Massachusetts Validation
Board, 1911.
250. Memphis, Tenn., water plant appraisal, 1902.
251. Michigan railroad appraisal, 1900-1901.
252. Minnesota railroad appraisal, 1908.
253. New Jersey Public Utility Commission, 1911.
254. New York Consolidated Gas Case, 1907.
256. New York Public Service Conmiission, First District, 1911.
256. Okkhoma Telephone Rate Case, 1911.
257. South Dakota raihx>ad appraisal, 1910.
258. Washington railroad i4>praisal, 1906.
259. Washington Raihroad Commission, 1910.
260. Seattle, Wash., Telephone Rate Case, 1910-1911.
261. Wisconsin railroad appnusal, 1903.
262. Wisooosin Railroad Commission.
280. Engineering and superintendence.
281. Contingencies.
282. Contingencies — Michigan railroad appraisal, 1900-1901.
283. Contingendes — Massachusetts appraisal of N. Y., N. H. & H. R. R.,
1911.
284. Contingencies — St. Louis Public Service Commission, 1911.
285. Contingencies— Oklahoma Telephone Rate Case, 1911.
286. Contingencies — ^^^soonsin Railroad Commission, 1911.
287. Contractor's profit.
288. Contractor's profit — St. Louis Public Service Commission, 1911.
289. Contractor's profit — New York Public Service Commission, First
District.
14 [209]
Digitized by VjOOQ IC
210 Valuation [§ 240
290. Contractor's profit — Valuation of Falmouth, Maas., water plant.
201. Interest during construction.
292. Interest — Minnesota Railroad Rate Case, 1911.
293. Interests-Oklahoma Telephone Rate Case, 1911.
294. Interestr—Wisconsia Railroad CosmiiaBiQOL.
295. Interest — St. Louis Public Service Conmussion, 1911.
296. Interest — New York Publie Service Cwnmifwion, First District,
1911.
297. Interest — State railroad appraisals.
298. Interest— Massachusetts appraisal of N. Y., N. H. A H. R. R.,
1911.
299. Promotion and organization.
300. Promotion — St. Louis Public Service Commission, 1911.
301. Promotion — New York Public Service Commission, Second District,
1908.
302. Promotion — ^New York Public Service Commission, First District,
1912.
§ 240. Introdiietofy.
Under the term overhead charges as here used are in-
cluded percentages on the cost of reproduction for the
following purposes:
1. Engineering and superintendence.
2. Contingencies.
3. Contractor's profit.
4. Interest during construction.
5. Legal and general expense, company organization,
taxes and insurance*
6. Promotion.
Bond discount, working capital, pieoemeiJ construction,
adaptation and solidification, franchise and going con-
cern while sometimes classified with overhead charges have
not been included here but have been made the subject
of separate chapters. Brokerage is treated with bond dis-
count in chapter 13. In a few appraisals, however, an
allowance for brokerage has be^i included with overhead
charges so that the tabulated overhead charges contained
in this chapter contain a few brokerage allowances. A
comparison of percentage allowances for overiiead charges
Digitized by VjOOQ IC
$240] Overhead Charges 211
is very dSffieuH; owing to the fact that specific percentageB
for specific purposes apply to diflferent items of the in-
yn^iocy in (fifferent appraisals. In the following tabula-
tions of overiiead charges the percentage allowance has
been placed on a comparable basis by giving the allowance
in terms of percentage of inventory cost. The inventory
cost is a term used to denote the total cost less all over-
head charges. It is the cost of all of the items of the ap-
praisal inventory prior to the addition of the overhead
charges. But even with the greatest care to reduce per-
centages to a comparable basis, great caution is necessary
in making comparisons. It is possible that in certain
cases the unit prices taken include certain overhead
charges. For example the unit prices may or may not
include a subcontractor's profit. In the earlier appraisals
the question of overhead charges received little considera-
tion, but with the more intensive study of valuation
proUems there has been a remarkable development in
the classification and amount of overhead allowances. It
is a question whether the present swing of the pendulum
is not fully as strong in the direction of excessive allow-
ances as it has previously been in the opposite direction.
The more equitable application of the reproduction
method assumes reproduction at present or average
prices but under the actual physical conditions and con-
ditions as to overhead expense under which the existing
iriant was actually and necessarily constructed. In most
eases a ccHnpany should be able to substantiate its claims
for overhead allowances by actual vouchers and other
records of such expenses incurred in the construction of
the plant. There is no necessity for leaving this matter
entirely to expert opinion as to such costs, based on some-
what hypothetical conditions of assumed reccmstruction.
Thn seems to be the position adopted by the St. Louis
Public Service Commission (see §§296, 300). The Wis-
Digitized by VjOOQ IC
212 Valuation [i240
consin Railroad Commission has taken a conservative
position in this matter and while allowing percentages for
overhead expense considerably above customary per-
centages in the earlier appraisals^ has resisted the recent
trend toward high estimates (see § 262). Though there
can be no question as to the existence and necessity for
these overhead expenses there are a few decisions that
seem to question their validity. Thus in the rate case,
Cedar Rapids Gas Light Company v. Cedar Rapids, 144
la. 426, 120 N. W- 966, 970, decided May 4, 1909, the
Iowa Supreme Court says:
Included in pIdntifF's estimate of values are: Interest on
capital during construction, $22,415; promotion and organiza-
tion, $14,943.69; and engineering, $18,679.61. These are
mere estimates of what might be expended for these purposes
in the construction of a new plant. Of course, all the money
required would not necessarily remain idle during construc-
tion, and the witness admitted that the only expense for pro-
motion and organization he could think of would be attorney's
fees in preparing proper papers. The expense for engineering
was said to be the percentage taken into consideration by those
contemplating such enterprises. Manifestly these, estimates are
largely speculative. Nothing can be allowed for the promo-
tion and organization of the company, for it is immaterial by
whom the plant may be owned in estimating its value.
To the same e£fect are the remarks of U. S. District
Judge Evans in the rate case, Cumberland Telephone
and Telegraph Company i;. City of Louisville, 187 Fed.
637, 646, 647, decided April 26, 1911:
First, what are called "overhead charges," which are made
up of various items of expenses incurred in the organization
of the company and its work, the details of which need not
be stated, but which it is claimed could not be avoided, and
which enter, as is insisted, into the present value of the plant.
These charges amounted to $90,000. . • •
Digitized by VjOOQ iC
§ 241] Overhead Charges 213
''Overhead charges'' consist of expenses much of. which were
incurred long ago. Probably those expenses may have aided very
materially in increasing the present value of the plant. That
present value we must ipscertain, but it does not follow that
"overhead charges" as a separate item should be included
as such. It seems to us that they are too intangible to be
available for that purpose.
§ 241. Appraisal of Chicago surface railwaysi 1906.
The property of the Chicago City Railway Company
and of the Chicago Union Traction Company was ap-
praised in 1906 by the Traction Valuation Conunission
consisting of Bion J. Arxiold, Mortimer E. Cooley and
A. B. DuPont. The appraisal was made under the au-
thority of a committee of the city council and was used
as the basis of the franchise settlement ordinances passed
February 11, 1907. The Traction Valuation Commission
explains its allowance for overhead charges as follows:^
In computing the values of the physical properties of the
companies, your commission has recognized the usual prac-
tice of engineers and financiers in respect to percentages to
be added to the various items of an estimate so that the total
may fairly represent the sum required to be invested in order
to bring the properties to an operative condition.
These percentages applied to different parts of the estimate
include organization, engineering, superintendence, and inci-
dentals, the latter item including contractor's profits, when
such are j ustly a part of the estimate. The total for this group
of- percentages varies on the different items from 5% to 15%,
as set forth in detail in connection with the items themselves.
To the sum of the separate estimates thus obtained it is cus-
tomary to add further percentages to cover:
* Report on the values of the tangible and intangible properties of the
Chicago City Railway Company and the Chicago Union Traction Com-
pany submitted to- the Comauttee on Local Transportation of the Chicago
City Council by Bion J. Arnold, Mortimer E. Cooley and A. B. DuPont,
Traction Valuation Commmpn, Deoember 10, 1906, p. 9.
Digitized by VjOOQ IC
214 Valuation [§ 241
1. Legal expenses, including those incuned in securing
the right-of-way and frontage consents.
2. Interest, or carrying charge for the money expended
during the construction period and up to the time the pix^
erty goes into operation.
8. Brokerage, or the expense of securing the neoessaiy
moneys.
4. Contingencies, to cover incomplete inventories, un-
foreseen difficulties of construction, and any and all other
items of expense which cannot be foreseen.
These items vary considerably in different dassds of con-
struction, but for the purpose of this appraisal, your commission
feels that it has been conservative in assigning a total of 10%
to cover the four items.
The 10% charge to cover legal expenses, carrying
charges, brokera.ge and contingencies was added to the
total estimated cost of rei»x>duction; 15% to cover organ-
ization, engineering and incidentals was added to repro-
duction cost of track, electric power distribution system
and buildings; 10% for organization, engineering and in-
cidentals was added to reproduction cost of power plants;
5% for organization, engineering and incidentals was
added to reproduction cost of cars and car equipment.
No percentage was added to reproduction cost of real
estate, patent rights, tools, machinery, stores, supplies,
office furniture and fixtures, horses, wagons and miscel-
laneous.
In the following tabulation the overhead chaises al-
lowed in this appraisal are shown in percentages of in-
ventory cost:
APPRAISAL OF CHICAGO CTTT RAILWAY, 1906.
Inventory-reproductiQQ-cost $19,629,395
Overhead charges 4,259,190
Cost-of-reproduction-new. . |23,888,S85
Digitized by VjOOQ IC
§ 242] OvEBOKAD Cbarqw 215
tory Coat
OiynMBtion, «i)smeerii^, auptriateBdenoe and
incicknUlfl J2^5,121 11.7
Legal expense, interest, brokerage and contin-
gencies 1,964,069 10.
Total Oveiiiead Clwiges ^269,190 21.7
In this appraisal the reproduction-cost-less-depreciation
was also determined and the overhead charges were de-
preciatecl to the same degree as other depreciable property
so that the percentage aHowance for overhead charges
remains the same.
i S42. Afpniaal of CSdcago CoMoUdated Tnictieii ComfUkj^
1910.
The ordinanoes passed February 11, 1907, for the ra-
OTgaaiaation and lehabiiitatiQn of the Chicago surface
lines were based 4in the above valuation. These ordi-
nances proidde lor purchase of the surface lines by the
dty on payment of the agreed valuation at the time of
the paasage of the ordinanoe, plus reimbursement tar any
subsequent capital investment, in determining the
amount of such an investment, actual cost and expense
to the company shall be taken plus an allowance to the
company of 10% ict conducting the work and joi 5% for
financing iSbe work. Hie f dlowing is bom 1 7 of the
Chicago City Railway Ordinance:
The company shaD purchase materials and equipment, and
employ enpneers, superintendents, clerks, foremen and work-
men and shall pay all expenses of every nature, includ-
ing legal expenses necessary to the proper, complete and
prompt performance of the above mentioned work, upon the
lowest advantageous terms and subject to the approval of
the said Board of Supervision Engineers, and to the actual
amount paid by the Con^iany in and about carrying out each
Digitized by VjOOQ IC
216 Valuation [§242
and all of the requirements of this section, shall be added ten
per cent of such amount as a fair and proper allowance to the
company for conducting the said work and furnishing said
equipment and five per cent for its services in procuring funds
therefor, including brokerage.
In 1910 the Chicago Railways Company acquired the
property of the Chicago Consolidated Traction Company
within the city limits (Ordinance of October 10, 1910).
In order to bring this property under the general provi-
sions of the ordinances of 1907, its present value was
appraised and a bonus of 15% added as provided under
the 1907 ordinances for new capital investment ''as a
fair and proper allowance to the company for conducting
the said work and furnishing said equipment" and ''for
its services in procuring funds therefor including broker-
age." This 15% therefore is not a true brokerage charge
but a bonus to be paid by the city in case of municipal
purchase and to be considered also in apportioning profits
between the company and the city. The other overhead
charges are the same as in the appraisal of 1906 noted
above with the exception that there was an allowance of
5% for legal expense, interest during construction and
contingencies, while in the 1906 appraisal there was an
allowance of 10% for the same items and brokerage. In
the following tabulation the overhead charges allowed
in this appraisal are shown in percentages of inventory
cost: *
APPRAISAL OF CHICAGO CONSOLIDATED TRACTION COMPANY.
Inventory-reproduction-cost $5,132,272.50
Overhead charges 1,971,434.79
Cost-of-reproduction-new $7,103,707.29
'Report on the values of the properties of the Chicago Consolidated
Traction Company inside the city limits submitted to the Committee od
Local Transportation of the Chicago City Council by Bion J. Arnold,
George Weston^ Traction Valuation Commisnon, August, 1910.
Digitized by VjOOQ iC
§243] OvEtiHBAD Charges 217
. . % Inverk-
Amount . ^ .
tory Cost
Organuation, engineering and incidentals .... S750,714.90 14.6
Legal expense, interest and contingencies .... 294,149.37 5.8
Conducting work, furnishing equipment and
brokerage (not a true overhead charge but a
construction bonus) 926,570.52 18.
Total Overhead Charges $1,971,434.79 38.4
In this appraisal the reproduction-cost-less-depreciation
was also determined and the overhead charges were de-
preciated to the same degree as other depreciable prop-
erty so that the percentage allowance for overhead charges
remains the same.
§ 243. Appraisal of Chicago gas plant, 1911.
William J. Hagenah, in his valuation of the property
of the Peoples Gas light and C!oke Company of Chicago,
with a view to determining a reasonable rate for gas,
based his allowance for overhead charges not on present
estimated charges in reproducing a similar plant complete,
but upon actual charges shown by the company's books on
work performed and upon the supposition that the entire
plant would be reproduced piecemeal during a ten year
period. He says:*
Although the valuation of the property is to be deter-
mined largely on the theory of the reproduction cost, it does
not necessarily follow that these costs should be determined
upon a basis more or less hypothetical, but, on the contrary,
that consideration should also be given to the actual costs
incurred in constructing the plant in question. The records
of the company are the best evidence as to what such over-
head expenses should be, and full weight has, therefore, been
given to the cost shown for expenditures of this character for
' Report by William J. Hagenah to the Gas Subcommittee of the Chicago
Cbuncil Committee on Gaa, Oil and Electric Light, in the investigation of
the FeopleB Gas light and Coke Company, April 17, 1911, p. 31.
Digitized by VjOOQ IC
218 Valuatiqh [§ 244
a number of the items during the last few years. The figures
used are based on the theory of the plant being constructed over
a number of years, or what is generally called the pieooneal-
construction |dan. If all the overhead charges were based
on the company's records for recent years the amount would
clearly be too small. It is, therefore, assumed for the determi-
nation of this question that the plant will be reproduced over
a period of approximately ten years, but it does not seem rea-
sonable that the same units of cost which are incurred in the
construction of the first half, or the first third of the plant,
should be used for the entire plant. In arriving at a fair over-
head charge, the assumed years of ocmstruction have been
divided into three periods and the items of expense increased
or reduced as shown to be justified from actual construction
records and the history of the plant in question.
For the purposes of the above investigation, Mr. Hag-
enah €8timated charges as follows (pages 31-33) :
1^ Period of Bd Period of Sd Period of
Construction Construction Construetion
Interest during construction 0% 5% 3%
Engineeriiig and Supervisian 5% 5% 4%
Organization and Legal Expenses. 3% 2% 1%
Taxes 1%
Contingencies 7% 6% 4%
Total 22% 17% 12%
The above shows ah avierage overhead charge of 17%
which is the percentage used by Mr. Hagenah in his valu-
ation for items other than land. Upon land he adds an
overhead charge of 12%. Although not included as an
overhead construction chaise, Mr. fiagenah also includes
an item of 0% for discount (m bonds.
§ 244. Cleveland street railway appraisal, 1909.
Judge Robert W. Tayler acting as arbiter for the jiarties
made a valuation of the property of the Clevdand Hail"
Digitized by VjOOQ IC
{2441 OvBBBB&D Qbaeges 319
way Company in 1Q09. Hub vahiatioD was made the
basis of a setUement wcMnanoe fising the terms of future
municipal purchase and also fixing rates of charge. Spedal
percentages of from 3% to 10% were first added to specific
items, on account of conditions making necessary a special
charge. In addition, to the total inventory vahie a per-
centage of 10% was added to cover organization, engineer-
ing, interest during. ooDBtFuction, etc. Tlie foUowing is
from Judge Taylor's decision: ^
I have divided overhead charges into two general classes —
those which af^y to the specific thkig, and those which apply
to the enterprise as a whole; tiie cqpecific tilings which are done
vary in the amount of overhead charge necessary in order to
complete the work, that is to say, the contingencies and un-
certainties and aecidents are laiger, for instance, in trade lay-
ing than they would be in the purchase or construction of
cars or other thing? of that character.
So that I have allowed as specific overhead charge applicable
to track, ten per cent; to pavement, three per cent; to cars,
land, buildings, overhead construction, return circuit, power
stations, storage batteries, miscellaneous rolling stock and
equipment, five per cent; and, to the oth^ items, nothing
specific, as applied to them, as, for instance, 8h<^ stores, aud-
itors' stores and bookkeeping credits. The result of those
is to make a total value up to that point of $15,175,585.28.
Now, we come to the subject of the general overhead charge
which is applicable to the whole investment and camiot be
separated or divided among the several items; some of tiiem,
if you took a separate item and undertook to apply the gen-
eral oveiiiefld dutrge, might not have an applioation peculiar
to that partioular item, but I have undertaken as bert I can
to arrive at a fair statement of what is the gaatf ad ovechead
charge in the construction of a property of this magnitude,
^Demmm cf Uaitad Siatei IXalriat Judga Bobeit W. Taykr in «fae
QMBttcr €f IbB aitttralaoa of the valuatioii of ibe property .of ttie Qlevelaiid
Railway Company, December 16 ami 17, li909.
Digitized by VjOOQ IC
220 Valuation [§245
for financing, engineering, legal expenses, organisation, ad-
ministration, insurance, including accident insurance, super-
intendence, interest during construction, delays not covered
by the specific allowances, consents, litigation with property
owners, incidentals and oontingendes not applicable to spe-
cific items, fifteen per cent; making the total actual physical
value $17,511,305.62,
In the following tabulation the overhead charges allowed
in this appraisal are shown in percentages of inventory
cost:
InveQtory-reproduction-coBt-leefrdepreciation S14,333,000
Total overhead charges 3,178,305
Cost-of-reproduction-les8-depreciation S17,511,305
In the above the allowance for overhead charges includes
allowance for financing, engineering, legal expenses,
organization, administration, insurance, superintendence,
interest during construction, delays not covered by
specific allowances, consents, litigation with property
owners, incidentals and contingencies. The total allow-
ance amounts to 18% of the inventory-reproduction-cost-,
less-depreciation.
§ 246. ColumbuSy OhiOi Electricity Rate Casei 1906.
Columbus Railway and light Company v. City of
Columbus is an electricity rate case. The master re-
ported in favor of a permanent injunction and his report
was approved by the court. No itemized reproduction
cost is approved by the master but from his discussion of
overhead charges and the total cost of reproduction as
found by him the following may be taken as a f air state^
ment:* .
* Columbus Bailway and light Company v. City of Columbus, no. 1266^
in equity, U. S. Circuit Court, Southern Dist. of Ohio, Eastern Diviaion,
Report of Special Master T. P. Linn, June 8, 1906.
Digitized by VjOOQ iC
$246] Oyeshsab Charges 221
Inventory-reproducibn-ooBt $1,457,730
Overhead duut^ges 142,270
Cartr4)f-ieproducti(m-iiew. $1,600,000
^-^ li'Z
General expenses, engineering, superintend-
ence and miscellaneous $09,270 6.8
Insurance 4,000 .3
Interest during construction 39,000 2.7
Total Overhead Charges $142,270 9.8
In this case the master did not consider cost-of-reptoduc-
tion-less-depreciation, so the question of depreci^ltion of
overhead charges did not come up.
§ 246. Des Moines, Iowa, Water Rate Case, 1910.
The case of Des Moines Water Company v. City of Des
Moines involves the validity of rates fixed by ordinance.*
The master reported that an injunction should be granted
an<i[ his report was approved by Judge Smith McPherson.
The master based his findingB as to reproduetion-cost-less-
depredation on two estimates. Estimate number 1 was
made up from the testimony of witnesses for the company
and estimate number 2 was made up from testimony of
witnesses for the city plus an apparently arbitrary addi-
tion of 20% upon certain items for contractor's profit
which made the total of estimate number 2 very nearly
equal to that of estimate number 1.
wrmkTB NO. 1.
Inventory-repitxilucticm-oost-less-depredation . . . $1,452,092
Overhead charges 233,856
Coet-of-repioduction-less-depreciation $1,685,948
• Des Moines Water Company v. Qty of Des Moines, no. 2468, in equity,
U. S. Circuit Coiut, Southern Diet, of Iowa, Central Division, Report of
Geofge F. Henry, Master in Chanoery» September 16, 1910.
Digitized by VjOOQ IC
222 VALUATioir [§ 247
Engineering, superintendence, contingencieB,
general and legal expenses S116,d28 8
Interest during construction 116,928 8
Total Overhead Charges. S233,866 16
ESTIMATB NO. 2.
]]iYentory-reproduct]oiMso8t-les»^q>reeiatkm . . . $1,301,141
Overhead charges 371,371
Go0i-of-iBproduction4ess-deiH»ciation. Sl,672,512
. %Inoenr
'^'^^ lory Cost
Engineering and superintendence S58,407 4.5
General expenses, legal expenses and con-
tingencies 80,059 6.1
Interest during construction 92,546 7.1
Contractor's profit 140,360 10.8
Total Oveiiiead Charges S371,371 28.5
In this case the estimates for total cost-of-reproduction-
new are not given by the master but his figures show that
the allowances for overhead charges both under Estimate
no. 1 and Estimate no. 2 were depreciated from 6% to
13% on the same allowances under cost-of-reproduction-
new.
§ 247. Lincoln, Neb., Oas Rate Case, 1909.
The case of linedn Gas and Electric Light Company
V. Caty of Lincdtt, 182 Fed. 926, 928, decided April 6,
1909, is an action to enjoin the enforcement of an ordi-
nance reducing the price of gas. In the following tabula-
tion the overhead charges allowed in the appraisal in this
case are shown in percentages of inventory cost:
Digitized by VjOOQ iC
$248] OVBRHEAD ChARGBS
hiFentoryHPqiiDdiictioiiHSOst, t525,324«72
Overiiead chiu^geB 40,417.04
OKtrof-i^vodoctioii-iiew. S565J41.76
^"•"^^ tory CmI
Eiigiueeriug expenses $12,417.04 2.4
Contingeiicies 25,000.00 4.7
Cost of organiiing cwnpany 3,000.00 .6
Toial OveriMiMl CbarpsB. $40,417.04 7.7
In this case fair value for rate purposes was based on
oost-of-reproduction-less-depreciation but the overhead
charges were not depreciated. There was no allowance for
interest during construction.
§ 248. Appraisal of street railways for Massachusetts Valida-
tion Board» 1911.
An appraisal of various street railways owned by the
New York, New Haven and Hartford Railroad was made
in 1911 in connection with an appraisal of that railroad.
These appraisals were made to determine the relation of
property to the amount of securities outstanding. The
work was in charge of George F. Swain. In his report
Mr. Swain discusses the overhead charges as follows (at
page 123}:^
In the preceding pages reference has been made to the ap«
prusais of trolley roads. These appraisals have been based
upon those made by Westingbouse, Church, Kerr & Co., which
were in great detail and entirely retiable. Some changes have
been made, however, in the overhead charges.
' Report to the Joint Board on the validation of assets and liabilities of
the New York, New Haven and Hartford Railroad under Chapter 062,
Acts of 1910, by George F. Swain, Engineer in Charge. Pnblished in Re-
port of the Massachusetts Joint Commission on the New York, New Haven
A Hartford Railrottd Company, February 15, 1911, pp. 51-154.
Digitized by VjOOQ IC
224 Valuation [§ 248
For these chai^ges, Westinghousey Church, Kerr & Co., used
the following:
Engineerings 5 per cent on total, including land, road and
equipment, and property not used in operation.
L^al and general expenses, 4 per cent on total, including
land, road and equipment, and property not used in operation.
Interest, 5 per cent per annum for an average of two years,
or 10 per cent in all.
Commissions, 10 per cent.
As the interest would apply not only to the property but
to the engineering and other overhead charges, except com-
missions, the total percentage would be about 30.
Price, Waterhouse & Co. adjusted these overhead charges
by making the charge for interest aad commissions 7 per cent,
instead of 20, assuming an average interest for only one year.
They therefore used a total overhead charge of about 16 per
cent on the entire cost of reproduction. No contingencies
were used in either of the above estimates.
Mr. Wells believed that the overhead charges used by West-
inghouse. Church, Kerr & Co. were too low. He reconmiends
and uses the following:
Administration, engineering and contractors' profit, 15 per
cent on total physical cost.
Insurance during construction, 1 per cent on total phys-
ical cost.
Legal and general expenses, 1 per cent on total physical
cost.
Interest during construction, 6 per cent on total physical
cost.
Total of the above, 23 per cent on total physical cost.
To this he adds brokerage 8 per cent of physical cost plus
the above overhead charges, or about 10 per cent of physical
cost, making a total overhead charge of about 33 per cent of
the physical cost of reproduction.
In order to be amply conservative, the following percentages
have been used in this report, and Mr. Wells's figures were
modified in accordance with them, namely:
Engineering, 5 per cent of physical cost of reproduction.
Digitized by VjOOQ IC
§249] OvEBHEAD Chabges 225
Contingencies, 5 per cent of physical cost of reproduction.
Legal and general expensesi 3 per cent of physical cost of
reproduction.
Total of the above, 13 per cent of physical cost of repro-
duction.
Interest, 6 per cent of physical cost of reproduction plus the
above, or about 7 per cent on physical cost of reproduction.
Commissions for marketing securities, 3 per cent of physical
cost of reproduction.
Making a total of about 23 per cent of physical cost of re-
production.
This is less than that used by 'VJTestinghouse, Churcby Kerr
& Co. and by Mr. Wells, but somewhat more than that used
by Price, Waterhouse & Co., which I am convinced is entirely
too low.
§ 348. Appraisal of N. Y., N. H. & H. R. R. for Massachusetts
VaUdation Board, 1911.
As indicated above, an appraisal of the New York, New
Haven and Hartford Railroad was made in 1911 with a
view to determining the relation of capitalization to
property value. In r^ard to overhead charges George F.
Swain, the engineer in charge of the appraisal, says (at
page 84):
The allowance which has been made for overhead charges is
as follows:
Engineering: — 5 per cent on the total cost, excepting the
land and equipment.
Contingencies: — ^5 per cent on the total cost, with the excep-
tion of the land and equipment, that is to say, the same charge
as for eiigineering.
Legal expenses: — 1 per cent on the total cost, with the ex-
ception of land and equipment, plus 2 per cent on the cost of
the land.
General expenses: — 1 per cent on the total cost, with the
exception of land and equipment, plus 3 per ce&t on the cost of
the land.
15
Digitized by VjOOQ IC
226 Valuation [§ 250
Interest and Gommisfiions: — 12 per oent on the total cost,
including land, but excluding equipment, and including also
engineering, contingencies, legal and general expenses.
There is, of course, more or less unc^tainty with regard to
the proper value to be assigned to these charges, and <^ini(Mis
and e3q)erienoe will differ regarding them. I am ccmvinced
that the above values are conservative and proper.
In the following tabulation these overhead charges are
shown in percentages of inventory cost:
Inventory-reproduction-coBt $259,635,934
* Overhead charges. . .* 40,333,824
Cost-of-reproduction-new S299,969,758
^^^ taryCost
Engineering $5,574,038 2.2
Contingencies 5,574,039 2.1
Interest and brokerage 23,554,678 9.
Legal expenses 2,475,389 1.
General expense 3,155,680 1.2
Total Overhead Charges $40,333,824 15.5
In this appraisal the reproduction-cost-less-depreciation
was also determined but the overhead charges were not
depreciated.
§ 260. Memphis, Tenn., water plant appraisal, 1902.
By voluntary agreement the City of Memj^iis pur-
chased the water plant of the Artesian Water Company
in 1902.^ Before purchasing the city had an appraisal
made by a board of three engineers (Arthur Hider, J. A.
Omberg, Jr., and A. T. Bell). In estimating the cost of
* Proceedings of the Legislative Council, City of Memphis, r8q)eeti]ig
purchase of the Artesian water plant and reparts of Committae an Waler,
Hydraulic Engineers, Certified Accountants, IQO^-IQQS.
Digitized by VjOOQ IC
{251] Overhead Chakges 227
reproduction of the plant, 10% was added to the entire
reproduction cost except the cost of land to cover engjoieer-
ing, expenses and contingencies. Tliere was no otiier per-
centage allowance for oveiliead charges included in the
vduation. In estimating depreciation in this case the 10%
allowance for engineering, expenses and eontmgoicies was
not depreciated.
§ 26L Michigan railroad appraisal, 1900-1901.
In 1900-1901 an appraisal of the reproduction cost of
the railroads of Michigan was made for tax assessment
purposes. The work was in charge of Prof. M. E» Cooley.
In the following tabulation the overhead charges allowed
in this appraisal are shown in percentages of inventory
cost: •
Inventory-reproduction-oost $170,291,556
Overhead charges 32,424,706
Cost-of-reproduction-new S202,716,262
^^'^^^^ Uny Cost
Engineering (6,886,772 3.2
Contingencies 18,428,759 10.8
Legal expense 673»349 .4
Interest during construction 5,290,549 3.1
Organisation. 2,645,277 L5
Total Overhead Charges $32,424,706 19.
In this appraisal the re{Ht)duction-cost-less-dei»«ciation
was also determined but the overhead charges were not
depreciated with the exception of the dlowanoe for con-
tingencies which was reduced to $15,127,110. The over-
head charges amounted to 21.2% on the inventory-
reproduction-cost-less-depreciation.
* Report of Midiigan Board of State Tax Commissionen, 1902, p. 52*
Digitized by VjOOQ IC
228 Valuation [§262
§ 262. Minnesota railroad appraisal, 190B.
An appraisal of the reproduction cost of the railroads of.
Minnesota was completed in 1908. It was made by
Dwight C. Morgan, engineer to the Minnesota Railroad
and Warehouse Conmussion, and was intended for use in
rate making. In the following tabulation the overhead
chaises allowed in this appraisal are shown in percentages
of inventory cost: ***
Inventory-reproduction-cost $345,260,418.73
Overhead charges 61,264,764.84
CoBt-of-reproduction-new $406,525,183.57
. . %Invenr
lory Cost
EngiDeeriiig, superintendence and legal ex-
pense $12,133,641.89 3.5
Ck)ntingencieB 17,869,703.02 5.2
Interest during construction 31,261,419.93 9.
Total Overhead Charges $61,264,764.84 17.7
In this appraisal the reproduction-cost-less-depreciation
was also determmed but the overhead charges were not
depreciated. The overhead charges amoimted to 20.8%
on the inventory-reproduction-cost-less-depreciation.
§ 268. New Jersey Public Utility Commission, 1911.
The New Jersey Public Utility Commission in its first
valuation for rate purposes, made an allowance of 12%
to cover engineering, superintendence and other expenses
during the construction period. The 12% is upon the
value of land and supplies as well as upon that of struc-
tures and equipment. In allowing 12% the Conmusaon
^ Report of Dwight C. Morgan, Engineer to the Minnesota RaihDad &
Warehouse Commission, on Minnesota raiboad appraisal, June 30, 1907.
In Annual Report of Minneeota Raihoad and Warehouae Co^miissiony
1006, pp. 17, 62.
Digitized by VjOOQ IC
§ 254] 0 V£RR£AEl CHAftGEB 229
states that it is following the practice of the Wisconsin
Railroad Commission."
§ 264. New York Consolidated Gas Case, 1907.
In the New York City Eighty Cent Gas Case the special
master discussed overhead charges as follows: "
In arriving at his final figures of the value of the plants as
a whole, Mr. Mayer adds to the contractor's figures, in the
case of the manufactiu'ing stations, 10 per cent., and in the .
case of the holder stations 5 per cent., to cover engineering and
general expenses of the company. This includes the planning
of the works, making of drawings, grading, paving, curbing,,
sewerage and drain pipes, temporary fences, operating tools
and other utensils, inspection and supervision of construction,
water for holder tanks and apparatus required for operation
of plant, as well as miscellaneous expenses for minor appa-
ratus, connections, etc., which cannot be included in a general
schedule. -He also adds an interest chaige of 5 per cent., cover-
ing the entire plant, on the supposition that it would take
at least two years to produce the plants as a whole, or, in other
words, that there would be an average interest charge of one
year at 5 per cent. These expenses amount in the aggregate
to $1,939,132.00. That expenses of this character are properly
to be included as a part of the cost of construction is a a mat-
ter of common experience and has been recognized in a recent
proceeding analogous to the present case. (Coliunbus Rail-
way & Light Company v. City of Columbus, j)ost,) The
allowance of 10 per cent, for engineering and miscellaneous ex-
pense does not appear excessive upon the evidence, which in-
dicates that as high as 15 per cent, is sometimes allowed for this
puipose. In assuTniug a construction period of at least two
" Re Investigation of rates charged by the Consolidated Gas Company
of Long Branch, New Jersey, July 25, 1911. New Jersey Board of Public
Utility Commissioners.
" Consolidated Gas Company 0. City of New York, U. S. Circuit Court,
Southern Dist. of N. Y., Report of Arthur H. Masten, Master in Chancery,
May 18, 1907.
Digitized by VjOOQ IC
230 Valuation [§ 255
years for the entire plant, Mr. Mayer is supported by Mr. Logan
as well as by Complainant's experts, although Mr. Logan ex-
pressed the opinion that the largest of the holders should be
built in from 9 to 10 months, and the smaller one in about
4 or 6 months. Mr. Edgerton allowed 3 per cent, for engineer-
ing and contingent expenses, although computing it not on
the original cost of construction but on his estimate of the pres-
ent value of the property as depreciated. His estimate of 3 per
cent, is based upon the amount which he assumes to have been
expended for similar purpose in the construction of the Astoria
plant, hereinafter described, but it was shown that such assump-
tion was erroneous, as Mr. Edgerton took into account only
a small portion of the expenditures of this character which
passed through (Complainant's books, while the actual engi-
neering and miscellaneous expenses have amounted thus far at
Astoria to upwards of 11 per cent. As to interest, he appears
to have allowed at the rate of 5 p^ cent, and a construction
period of somewhat less than two years. Mr. Marks m^e no
spedfic allowance for either of these items, stating that al-
though proper to do so in making estimates it is not customary
in the case of inventories of apparatus already erected. But
obviously they are a necessary part of any estimate of reproduc-
tion cost, as Mr. Marks admitted.
§ 26fi. New York Public Service Commi8sioii» First District,
19U.
The case of Mayhew v. Kings Ck>unty lighting Com-
pany, 2 P. S. C. 1st D. (N. Y.) — , decided October 20,
1911, involves the valuation of a gas plant for rate pur-
poses. Commissioner Maltbie discusses the question of
overhead charges in part as follows:
As "net cost" covers only the cost of labor and materials,
including subcontractors' profits when proper, some allowance
should be made for engineering, supervision, contingencies,
incidentals and general contractor's profit. In view of the size
of the company, the nature of the business, the way in which
it has grown and the lack of records showing actual expendi-
Digitized by VjOOQ IC
§255] OvsRHBAD Chabgbs 231
tuiesy it 18 estmukted that 4340,000 should amply provide for
Budi additional items. . • •
The estimated allowance for these items consiats of an al-
lowanoe of 10 per cent for general contractor's profit and 15
per e&ii for engineering, incidentals, etc., upon the items to
which these charges would properly apply. (See Table II.) It
seems proper in this case to allow 15 per cent for the latter
group, though in some cases before the Commission, the allow-
ance has not been m excess of 10 per cent or 12 per cent. In
such cases there was a thorou^ examination and checking and
rechecking of the property by the engineers, and inventories
were made separately by different engineers and corrected
from time to time. In the present case, inventories and ap-
praisals have not been made with such great care, and it is
proper to make allowance for this fact. Further, the gross
amount is not large in this case, and a percentage basis is
not always the only accurate standard.
la addition the Commission added $140,000 for ''pre-
liminary and development expenses." This was intended
to cover promotion expenses, interest and taxes during
oonBtriM^ion and trial operation, adjustnoent of parts,
etc., b^ore operaticm begins. In the following tabula-
tion the overhead chaises allowed in this appraisal are
shown in percentages of inventory cost:
Inveatory-reprodttotiHi-eost S2,211,628
Overhead charges 601,149
CoBtpof-reproduction-new $2,812,777
. . % Inven-
^""^ lory CoH
Contractor's profit, engineering and adminis-
tratmi, oontiiig!Bnffieg and incidentals 1341,149 15.4
Preliminary and development expenses 260,000 11.7
Total Overhead Charges $601,149 27.1
In this case fair value for rate purposes was based largdy
Digitized by VjOOQ iC
232 Valtjation [§ 256
on cost-of*reproduction-less-depreciation and the allow-
ance for contractor's profit, engineering, administration,
contingencies and incidentals was depreciated to the same
extent as the depreciable property to which these allow-
ances were applied. The item for preliminary and develop-
ment expenses which included also interest and taxes dur-
ing construction was not depreciated.
§ 266. Oklahoma Telephone Rate Case, 1911.
The case of Pioneer Telephone and Telegraph Com-
pany V. Westenhaver " involves the valuation for rate
purposes of the telephone plant in the City of Enid,
Oklahoma, of the Pioneer Telephone and Telegraph Com-
pany. The Oklahoma Corporation Commission allowed
10% for engineering and supervision. This allowance
was accepted by the State Supreme Court. The Corpora-
tion Commission made no allowance for contingencies,
piecemeal construction, or interest during construction
and such allowances were contended for on appeal to the
Supreme Court. The Supreme Court refused to make an
allowance for contingencies or for piecemeal construction
but allowed $4,000 for interest during construction.
§ 267. South Dakota railroad appraisal, 1910.
In 1910 an appraisal was made of the reproduction cost
of all the railroads of South Dakota. The appraisal was
intended for rate purposes and was made imder the direc-
tion of the Railroad Commissioners by Engineer Carl C.
Witt. In the following tabulation the overhead charges
allowed in this appraisal are shown in percentages of
inventory cost: "
*> Pioneer Telephone and Telegraph Company v, WeBtenhaver, 29 Okl.
— , 118 Pac. 354, January 10, 1911.
^* Report of Carl C. Witt, Engineer in Ghaige (A railway appraisal to the
Board of Railroad Ck>mmiB8ioner8 of South Dakota on the physical valua-
tion of the railroads of South Dakota as of June 30, 1909. In Twenty-first
Annual Report of South Dakota Railroad CommisslanerB, 1910, pp. 29, 33b.
Digitized by VjOOQ IC
§258] Overhead CHAaass 233
Inventory-reproduction-cost ^,609,443
Overhead charges 12,885,060
CoBi-of-reproduction-iiew $106,494,503
. . %Invenr
^"•^ taryCoa
Engineering, superintendence and legal expense $3,645,811 3.9
Contingencies 5,349,039 5.7
Other expenses 972,552 1.
Interest during construction 2,917,658 3.1
Total Overhead Charges $12,885,060 13.7
In this appraisal the reproduction-cost-less-depreciation
was also determined but the overhead charges were not
depreciated. The overhead charges amounted to 16.3%
of the inventory-reproduction-cost-less-depreciation.
§ 268. Washington railroad appraisal, 1908.
In 1908, Halbert P. Gillette, consulting engineer to the
Washington Railroad Commission made an appraisal of
all the railroads of the State. The physical values de-
termined by this appraisal were adopted by the Com-
mission as formal findings of fact and were subsequently
used in various rate cases. These findings of fact contain
the following in relation to overhead charges for the
Northern Pacific railroad (fijiding no. 29) : "
That a reasonable and fair allowance for engineering ex-
penses would be three and one-half per cent of the cost of re-
producing the gradings, tunnels, bridges, trestles, culverts,
ties, rails, track fastenings, frogs and switches, ballast, track
laying and surfacing, fencing, crossings, cattle guards and
i*See article entitled "Original cost and cost of reproduction of the
Northern Pacific Railway in the State of Washington," in Engineering and
Contracting, Jan. 12, 1910, pp. 44, 45. See also findings as to the value
of raiboada and other facts, in Second and Third Annual Reports of the
Railroad Commission of Washington, 1907-1908, pp. 127-499.
Digitized by VjOOQ IC
234 Valuation [§ 258
signs, interlocking and signal apparatus, telegraph lines, trans-
IK)rtation department buildings, shops, round houses, turn
tables, road department buildings, shop machinery and tools,
water stations, fuel stations, storage warehouaea and mis-
cellaneous structures.
That a reasonable and fair allowance for legal and general
expenses would be one per cent on the items mentioned in
connection with engineering expenses, together with one
per cent on the amount paid out for taxes during construction.
That a reasonable and fair allowance for interest during
construction would be seven and one-half per cent of the items
last hereinbefore mentioned, plus the amount necessary for
section equipment, legal and general expenses, costs of en-
gineering and the value of the right-of-way and terminals.
No allowance was made for contingencies. Chief Engi-
neer Gillette in charge of the appraisals says in his report
that as a detailed examination was made of the records
of the companies to find the cmginal cost, an allowaace for
contingencies became unnecessary. Theae percentages
are not added to total inventory cost but to various iteoos
of cost so that the total percentage overhead charge is not
so large as it at first appears. In the fdlowing tabulation
the overhead charges allowed in this appraisal are ^own
in percentages of inventory cost:
APPRAISAL OF NORTHERN PACIFIC RAILWAY
Inventory-reproduction-cost $97,408,854
Overhead charges 5,673,911 ^
Cost-of-reproduction-new $103,082,765
, , % Invent
AmcmrU ^ ^^
Engineering $2,510,580 2.6
Legal and general expenses 502,116 .5
Interest during construction 2,661,215 2.7
Total Overhead Charges $5,673,911 5^
Digitized by VjOOQ iC
§259] OvEBHBAD Charges 235
In this appraisal the reproduction-cost-less-depreciation
was also determined but the overhead charges were not
depreciated. The overhead chaises amounted to 6.9%
on the inventory-reproduction-cost-less-depreciation.
§ 269. Washington Raiboad Commission, 1910.
Very much higher overhead charges than those above
indicated were allowed by the Washington Railroad Com-
mission in its valuation of an interurban railroad for rate
purposes in 1910. These allowances reduced to per-
centages of inventory cost are as follows: ^
Inventory-reproductioii-coBt $3,177,768
Overhead charges 499,517
Co6lrof-reproduction-new $3,677,286
% Inrnir
^^^ taryCost
Elngmeermg and snperintendenee $53,336 1.7
Fiseal and phyeieal auperviaian and managemeiit 186,955 5.9
ContingencieB 96,266 3.
L^al and general expense 17,779 .5
Interest during construction 145,181 4.6
Total Overhead Chaiges. $499,517 15.7
In this appraisal the reproduction-cost-less-depreciation
was also determined but the overhead charges were not
d^reciated. The overhead charges amounted to 19%
on tbe inventory-repioduetion-cost-less-d^ureciation.
§ 260. Seattle, Wash., Telephone Rate Case, 1910-1911.
In order to determine reasonable rates for telephone
service, an appraisal of physical property was made for
the Seattle department of public utilities by C. H. Judson
i^P^ulhamue v. Puget Sound Electnc Railway, Opinion and order of
the RaibxMd Conunisaon (rf Washington, February 26, 1910, no. 76, p. 63.
Digitized by VjOOQ IC
236 VALtJAHOK [S 260
and Frank B. Hall, engineers, in 1910. In their report
Messers Judson and Hall say: ^^
In placing a valuation on the plant, prices on all materials
used were procured from manufacturers, agents and dealers,
f. o. b. Seattle, at present market prices; from these prices,
together with the cost of labor, and the customary allowance
of 10% for engineering and superintendence, 10% for general
expense and 6% for interest, a unit schedule of costs was pre-
pared covering all parts of the plant except Central Office
Equipment, Real Estate and Buildings, and the valuation fig-
ured out from the itemized inventory. On Central Office
Equipment the original copies of contracts for the installation
of apparatus was taken for that part installed in the various
exchanges by the Stromberg-Carlson Telephone Manufactur-
ing Company, and a imit schedule of costs prepared covering,
that part installed by the company, with the usual 10% added
to all for engineering and superintendence.
The case was then submitted to the Washington Railroad
Conunission for determination and Henry L. Gray, en-
gineer to the commission, made an independent appraisal.
In regard to overhead charges, Mr. Gray says: "
There was included in the estimate an allowance for en-
gineering, supervision and organization expense, amounting to
10 per cent of the cost of all labor and material; for interest
during construction, 5 per cent of the cost of all labor and
material, including engineering, supervision, etc., based upon
the assumption that two years would be required to recon-
struct the plant and that the sum required would be invested
an average of one-half of the time, the interest rate being 5 per
^' Report to the Department of Public Utilities of the City of Seattle on
the value of the properties and cost of service of the Independent Telephone
Company and the Pacific Telephone and Telegraph Company by C. H.
Judson and Frank B. Hall, Engineers, September 26, 1910.
^ Appraisal of the Seattle Telephone Companies for the Railroad Com-
mission of Washington, by Henry L. Gray, in Engineering and Contract-
ing, May 3, 1911, pp. 520-24.
Digitized by VjOOQ iC
§ 261 ] Overhead Charqes 237
cent per annum. Contingencies were provided for by an al-
lowance of 5 per cent of all preceding items. No item for dis-
count was included, but an allowance of 5 per cent of 75 per
cent of the total estimated cost of reproduction was made to
cover brokers' fees, based upon the theory that if 26 per cent
of the capital stock was paid up, the bonds would sell at par,
the brokers' commissions amounting to 5 per cent. The total
net loading charge, composed of the percentage allowances
for engineering, supervision and organization expense, interest,
contingencies and brokers' fees, amounted to 23.82 per cent.
§ 261. Wisconsin railroad appraisal, 1903.
For tax assessment purposes Prof. Wm. D. Taylor,
engineer to the Wisconsin state board of assessment,
made an appraisal of the railways of the State for the
year ending June 30, 1903. In the following tabulation
the overhead chaises allowed in this appraisal are shown
in percentages of inventory cost: *•
Inventory-reproduction-cost S179,223,284
Overhead charges 23,692,921
Cost-of-reproduction-new $202,916,205
. ^ % Inmnr
^^^ icryCost
Engineering, superintendence and legal expense S6,253,188 3.5
Contingencies 9,857,280 5.5
Interest during construction 5,376,698 3.
Organization 2,205,755 1.2
Total Overhead Charges. $23,692,921 13.2
In this appraisal the reproduction-cost-less-depreciation
was also determined but the overhead charges were not
** 'Report of Prof. Wm. D. Taylor, Engineer to the State Board of Aaeemh
ment, upon the appraisal of the physical properties of the Wisconsin rail-
ways for the year ending June 30, 1903. In Report of the Wisconsin Tax
Commission, 1997, pp. 269, 285.
Digitized by VjOOQ IC
238 Valuation [§ 262
depreciated. The overhead charges amounted to 16.5%
on the inventory-peproduction-coet-lees-depreciation.
§ 262. Wisconsin Raiboad Commission.
In valuations made by the Wisconsin RaUroad Com-
mission for rate regulation or for municipal purchase, the
general rule as to water, gas and electric plants has been
to allow 12% on the total inventory-reproduction-cost to
cover engineering, superintendence, legal expenses, in-
terest during construction and contingencies. The 12%
allowed is not usually segregated between the above items
but in certain cases the Commission has said that the 12%
allowance was made up of 5% for engineering and super-
intendence, 4% for iaiereat during construction and 3%
for legal expenses, <H:gamzati(m, casualties, omissions,
etc.^ In a few cases the total overhead charge has been
10% but 12% seems now to be the general rule. In certain
cases the companies have contended strongly for a higher
percentage but the Commission has rejected the demand.^^
§ 280. Engineering and superintendence.
Some allowance for engineering and superintendence is
made in all appraisals.
The case of City of Bipon v. Ripon light and Water
Company, 5 W. R. C. R. 1, 13, decided March 28, 1910,
involves the valuation of a water and gas plant for rate
purposes. In regard to engineering and superintendence
the Wisconsin Commission says (at page 13) :
The allowance of 5 per cent for engineering and superin-
denoe is m accord with accepted practice and, when applied
osk the total cost of the physical plant, will in all probability
" See Qty of Ripon v, Bipon light aad Water Company, 5 W. R. C. R.
1, 13, decided Mareh 28, 1910.
*^ Re LaCroBsGaB and Bleotric Company, 8 W. R. C. R. 138, 157, No-
vember 17, 1911.
Digitized by VjOOQ IC
§280] OVBRHEAD ChARGEB — ENGINEERING 239
exceed rather than fall short of the true expense for tnis pur-
pose. The latter is more likely to be true of the small plant,
in the construction of which engineering complications are
quite mfrequent. The physical valuation upon which such
percentage is computed is the value of the plant in its present
entirety, consisting of the original plant, plus the additions
and the betterments over a number of years. These additions
consist of a large number of separate charges, many of them
for improvements of a comparatively simple nature. The
services of engineers are seldom engaged in such instances,
these duties being performed by the general officers of the
plant whose entire salaries are included in operating exx)enaes.
Every aggressive and progressive utility is constantly called
upon to make additions in order to adapt itself to the chang-
ing needs of the community served. The determination of
Uiese changes is within the legitimate scope of the general
officers' duties, so that an allowance of 5 per cent on the total
value can be regarded in no other light than that of liberality.
The same subject is discussed by George F. Swain in his
report to the Joint Board on the validation of assets and
liabilities of the New York, New Haven and Hartford
Railroad.** This is a valuation for purposes of capitaliza-
tion. Mr. Swain says (at page 58) :
The charge for engineermg is a necessary one in the execu-
tion of any engineering work. It includes the salaries of en-
gineers, draftsmen, inspectors, etc., and in general all the expert
services required for design and superintendence. The amoimt
of this charge will, of course, vary according to the kind of
work. In the case of a railroad it is generally as large as has
been assumed, if not larger. In the first place, a lai^e expense
has to be incurred for preliminary surveys, to determine the
proper location of the line. The expense of this work will
vaiy according to the topography. In a level country, as in
n pabfibfaed in Report of the Maasachusetts Joint Commission on the
New Yoik, New Havvo ^ Hartford Bailioad Company, Febniary 15, 1911,
pp. 51-154.
Digitized by VjOOQ IC
240 Valuation [§ 281
our western states, where a railroad can be located anywhere,
the expense may be comparatively small, while in a moimtain-
ous country a large sum may be expended before the proper
location is found. After a preliminary survey has fixed the
route approximately, the precise location has to be determined
and the line laid down upon the groimd. Contracts and speci-
fications are then prepared, designs made for the different
portions of the work, and contracts let for its construction.
These contracts require supervision on the part of the en-
gineering force, and estimates of quantities to serve as a basis
of payments to the contractor. Inspectors are also necessary
to see that the specifications are properly carried out. Five
per cent, is a common charge for engineering, used in prelimi-
nary estimates of cost. Actually, as explained, the charge
may be greater or less, but is frequently greater. For instance,
to give some examples, the following have been the engineer-
ing charges for work in Boston and vicinity: —
East Boston tunnel about 6.4 per cent.
Washington Street tunnel about 6.1 per cent.
Metropolitan water works about 6.2 per cent.
In the latter case, the percentage is estimated on the total
cost, exclusive of overhead charges, but of this total cost nearly
50 per cent, was for the purchase of existing water works, on
whrch there was no engineering charge, so that the engineering
charge on the balance would be nearly 12 per cent. A charge
of 5 per cent, will therefore be seen to be low. Personally, I
believe it should not be less than 6 per cent.
§281. Contingencies.
Some allowance for contingencies is customary in any
appraisal that is not ba^ed on complete records of work
recently constructed. In discussing railroad appraisals
J. E. Willoughby says: "
After the estimate has been made, including the item for sea-
» ProoeedingB of American Society of Civil Engineens, Jwuary, 19Uy
p. 119.
Digitized by VjOOQ iC
§ 282] Overhead Ghabob0*-<;!ontinoencies 241
Boning and adaptation, there should be added a contingent
fund to cover the omitted work, consisting of small borrow-
pits and ditches, undetermined foundations, unexpected con-
ditions encountered, unavoidable ''force account" work,
minor changes of streams and highways, damages to adjoin-
ing lands due to the methods of construction and to diver-
sion of water, etc. This item will not exceed 5% of the cost
of the roadway if the estimate be accurately made.
In the general state raiboad appraisals, Michigan, Wis-
consin, Minnesota and South Dakota made a special al-
lowance for contingencies, while Texas and Washington
made no such allowance. Chief Engineer Gillette, in his
report on the Washington valuation, states that inasmuch
as a detailed examination was made of the records of the
companies showing the original costs and amounts, an
allowance for contingencies was unnecessary.^^ Engineer
Morgan, in his report on the Minnesota valuation states,
that, while engineers allow 10% to cover contingencies on
any estimated cost of new construGtion, he believes that
an allowance of 5% is all that is required in making an
appraisal of a railroad already constructed.^'^ He says:
''The essential difference rests in the fact that in repro-
duction cost the estimate is prepared in the light of known
conditions, whereas for a projected line, the contingencies
are wholly unknown." In Paulhamus v. Puget Soimd Elec-
tric Railway, decided February 26, 1910, the Washington
Railroad Commission allowed 5% for contingencies on the
cost of reproducing the roadbed and other structures.
§ 282. Contingencies— Michigan railroad appraisdy 1900-
1901.
Henry Earle Riggs in his account of the Michigan rail-
^ See Seeond and Third Annual Reports of the Railroad Ck)minia8ion
of Washington, 1907-1908.
* See Annual Report of Minnesota Railroad and Warehouae Commis-
flkm, 1908, p. 43.
16
Digitized by VjOOQ IC
242 Valuation [§ 282
road appraisal ^ states that there was considerable crit-
icism of the allowance of 10% for contingencies. He
maintains that the allowance was a proper one in the
Michigan appraisal, and gives the following reasons:
(a) The conditions under which this particular inventory
and appraisal were made, as to time and lack of co-operation
of the companies, made it practically certain that some items
of value were missed in the appraisal, such as station and mis-
cellaneous equipment, frogs, switches, track structures, build-
ings owned by the companies and occupied by others, etc.
(b) That there were many and large elements of physical cost
not ascertainable by a physical inspection, such as deep founda-
tions, many thousands of yards of earth in swamps and sink-
holes (a very general condition of roads in the Southern Pe-
ninsula), concealed classification due to growth of grass or
washing of banks, and many other cases of work actually done,
invisible after a lapse of years. The writer knows of many such
instances on property which was in his charge many years ago;
in several . cases there were expenditures of from $20,000 to
$50,000 which are now entirely invisible to an engineer pass-
ing over the line, (c) The failure on the part of railroad com-
panies to keep anything like a complete history of construc-
tion operations, and the changes of operating officials from
year to year, cause the loss of record of practically all the ex-
pense due to extra hazard and risk which the construction
engineer provides for by his " contingencies," (d) The inclusion
in operating expense, every year, of sums which are properly
construction, and which, if added to unit prices of construc-
tion work, would cause the cry that such unit prices were too
high. For instance, the appraisal estimate on earth was 17
cents per cu, yd., with no allowance for overhaul. Very much of
the grade in the State had actual costs far in excess of this fig-
ure, and practically every road spends a large sum annually for
the first four or five years, which is charged to operation but
is in reality a part of the cost of completing the roadbed, (e) No
** See Proceedings American Society of Civil Engineera, November, 1910,
p. 1418.
Digitized by VjOOQ IC
§283] Overhead Charges — CJontingbncies 243
account was taken of appreciation of any of the elements en-
tering into a road. There is no doubt that roadbed, for ex-
ample, does appreciate, due to ballasting and track work.
These items go far toward accounting for the contingencies
item on an old road such as the Michigan Central. (/) There
is a considerable amount of cost, which cannot be taken out
of capital, where facilities are abandoned or line or grade
changed. These changes are conmion to all growing roads;
they are due to the demands for greater traffic; they are nec-
essary to the welfare of the conmiunity served; they are often
made at points where no charge of defective design will apply.
They might be termed expenses due to the development of
the State, and, in the development of the railroad business,
they were absolutely necessary for its present standard of
efficiency. They are incapable of exact and definite determi-
nation, and must of necessity be included as contingent ex-
It is to be noted that in the above, Mr. Riggs, in part at
least, includes under contingencies, the cost of adaptation
and solidification of roadbed, for which a special allowance
has been made in various railroad appraisals. It should
be noted also, that he includes under (/) various expenses
for capital sunk in changing line or grade, and that these
are expenses which under approved systems of accounting
are taken care of by depreciation reserves.
§ S183. Contingencies— Massachusetts appraisal of N. T.| N.
H. & H. R. R., 1911.
George F. Swain, in his appraisal for purposes of cap-
italization of the property of the New York, New Haven
and Hartford Railroad, discusses the allowance for con-
tingencies as follows (at page 86) : ^
' Report to the Joint Board on the validatioii of aasets and liabilitiee of
the New York, New Haven and Hartford RaUroad under Chapter 652,
Acte of 1910, by George F. Swain, Engineer in Charge. Published in Re-
port of the Maasachufietts Joint Commission on the New York, New Haven
ft Haitfoid Railroad Company, February 16, 1911, pp. 51-154.
Digitized by VjOOQ IC
244 Valuation [§284
It might perhaps be supposed that in an appraisal (rf exist-
ing property no allowance should be made for contingencies.
This, however, is not the case, for there are many elements
which would enter into the cost which are not represented
in the inventory. Among these may be mentioned the follow-
ing: damages incidental to the work, such, for instance, as in-
terfering with a farmer's water supply, or cutting off access
to his land; temporary structures which have been built in the
progress of the work, but which aie afterwards removed; foun-
dations of structures, the difficulties incident to which are en-
tirely uncertain, since the foundations thonselves are below
ground or below water and inaccessible; dredgmg incident to
the construction of foundations in water; expense incident
to the presence of quicksand or water in cuts, which after the cut
has been made and the ground drained are not easily realised ;
subsidence of embankments where they pass over swamps;
temporary stations, bridges and other structures required,
in case work such as double tracking, or the elimination of
grade crossings, should be carried on subsequent to the origi-
nal construction of a portion of the road; similarly, expenses
incident to other improvements if made subsequent to first
construction, such as reducing grades, involving lowering
cuts while maintaining traffic, in which case, especially if
the cut is in rock, the expense is enormously greater than it
would be to construct the line in its final form in the first
instance; increase in quantity of ballast over that estimated,
due to the fact that some of it gradually works into the grading;
and many other elements which might be enumerated. . . .
Personally, I believe this charge, like that for engineering,
should be more than 5 per cent., but I have taken it at the
latter figure.
§ 284. Contingencies— St Louis Public Service Comnii8sion»
1911.
In the valuation for rate purposes contained in a report
of the St. Louis Public Service Commission to the Munic-
ipal Assembly on rates for electric light and power, Febru-
ary 17, 1911, the Gonmiifision did not indude a general
Digitized by VjOOQ iC
§285] OVBRHBAD CHABOBa— CONTINOENCISS 245
overhead charge for oontingencies but induded a per-
centage for contingencies on 8pe<»fio items in cases where
it was deemed necessary. Thus in valuing the overhead
and underground systems there was a 5% gm»d con-
tingency allowance but this allowanoe did not represent
aU of the contingency allowance made as it is stated that
most of the subitems contained some special percentages
for contingency,
§ 286. Contingencies— OUahoma Telephone Rate Casei 1911.
In the case of Pioneer Telephone and Telegraph Com-
pany V. Westenhaver, involving the valuation of a tele-
phone plant for rate purposes, the company asked for an
allowance of about $2,000 on a total cost to reproduce of
$94,000 to cover contingencies. The Oklahoma Supreme
Court, however, disallowed this item.^
Item No. 1, it is contended, should be aUowed to cover un-
foreseen emergencies and contingencies which always add to
the cost of construction, but are not visible in the completed
structure, such as loss, breakage, or destruction of material
and emergencies requiring extra labor. It may be that re-
placement costs in some cases cannot be correctly ascertained
without a separate allowance of the character here contended
for; the amoimt of such allowance to be determined by the
character of the plant, of the physical units of which it is com-
posed, the character of labor required to construct it, and the
experience of others in constructing other similar plants; but
the evidence in behalf of appellant that any amount should
be allowed in this case is very meager. There is a statement of
one of its witnesses that the arbitrary sum of 5 per cent, of the
reproductive value of the physical units in the complete plant
should be allowed for this purpose. We do not think this oan*
tention sofiicientily siqiparted by the record to require the
holding of the Comiaissi<m on this item to be disturbed.
* Pioneer Telephone and IVlegrapli Oompany v, Weat^iliayer, 2t OkL
— , 118 Fm. 854, 3fi6, Jamxy 10, 1911.
Digitized by VjOOQ iC
246 Valuation [§ 286
§ 286. Contingencies— Wisconsin Railroad Commissioni 1911.
The Wisconsin Railroad Commission has imiformly in-
cluded a comparatively small allowance for contingencies.
This question is discussed in the case of City of Beloit v.
Beloit Water, Gas and Electric Company, 7 W. R. C. R.
187, 239, decided July 19, 1911:
These remarks aid us in making the distinction, which should
be emphasized, in regard to the difference between estimates of
construction cost and estimates of the cost of reproduction. It
is ordinarily impossible for the designer of plants, such as those
involved herein, to foresee the exact conditions and contin-
gencies which may be encountered in the actual construction
work. This is true to some extent even where specifications
and estimates are drawn by men of large experience and fa-
miliarity with local conditions. Again, it is seldom but what
departures are made from specifications, due to new inventions,
changes of policy on the part of those in control of the work,
the encountering of unforeseen conditions, and for numerous
other reasons. In fact, specifications are often purposely left
open in some particulars to permit of changes due to later de-
cisions by those in charge. On the other hand, the cost of re-
production of such properties is made after the plant has been
completed and with all units and equipment in place and the
plant in operation. Access is often had in valuation work of
this kind to the books and records showing the actual cost of
construction of all or a part of the physical property. Again,
where unusual conditions were met with in the construction
work which called for particular skill and caused additional
expense not provided for in the original estimates, these cir-
cumstances are not commonly permitted to escape the atten-
tion of those conducting the inventory and appraisal.
§ 287. Contractor's profit.
A specific allowance for general contractor's profit has
not usually been included in appraisals. Whether such
an allowance should be included depends on the method
of determining the unit prices. If the unit prices are
Digitized by VjOOQ IC
§288] Overhead CflAiiQfis— Contractor's Profit 247
based on cost to a general contractor and such cost is less
than the cost would be were the company to do the work
without such contractor then there should be an allowance
for contractor's profit. If, however, the unit prices are
based on the actual cost of such work performed without
the intervention of a general contractor, there is no occa-
sion for the addition of contractor's profit. Cost with
contractor's profit added should not at least be greater
than the price at which the company could do the work,
for it is only in case the general contractor will do the
work cheaper that there is any justification for procuring
his services.
In the valuation of the Chicago surface railways, per-
centages on various items of from 5% to 15% were al-
lowed to cover organization, engineering, superintendence,
and incidentals. It was stated that the item ' ' incidentals "
would include contractor's profits when *'such are justly
a part of the estimate." In Paulhamus v. Puget Sound
Electric Railway, decided February 26, 1910, the Wash-
ington Railroad Commission states that while making no
percentage allowance for contractor's profit, an amount
has been added to the unit prices of material ordinarily
handled by contract sufiScient to allow for contractor's
profit.
§ 288. Contractor's profit— St Louis Public Service Commis-
sion, 1911.
In the valuation for rate purposes cpntained in a report
of the St, Louis Public Service Commission to the Munic-
ipal Assembly on rates for electric light and power,
February 17, 1911, the Commission declined to make an
allowance for general contractor's profit. The Commis-
sion says (Report, pp. 45 and 46) :
The company's claim for a contractor's profit of 10 per cent.
to be added to the construction cost of the plant under the
Digitized by VjOOQ IC
248 Valuation I § 28d
assuQiption that in rebuilding the plant new the vrhole woik
would be let to a general contractor, illustrates very clearly
the difference in treatment of the whole question as advanced
in their theory of cost of reproduction new, and the method
adopted by the Commission.
The Commission takes the position that as a matter of fact,
there was no general contractor's profit. Moreover, in the
creation of such plants as the one under consideration, as they
are generally created, there is seldom such an expenditure.
It has been argued that if such a plant were to be created
new it would be economy to employ a general contractor, but
in taking the figures upon which to base their profit, the com-
pany has used approximately the actual construction cost
of a plant created without such contractor, and therefore with-
out the assumed consequent economy. These facts make the
company's position inconsistent, and would prevent the con-
tractor's profit being added to the original cost even if the
commission admitted the correctness of allowing such a charge
to enter into the value of the property.
§289. Contractor's profit— New York Public Service Com-
missioni First District.
In the appraisals made by the New York Public Service
Commission for the First District, the unit prices them-
selves include for certain items a subcontractor's profit
and there is included in addition a percentage allowance
for general contractor's profit. Re Third Avenue Rail-
road Reorganization Plan, 2 P. S. C. 1st D» — , decided
July 29, 1910, involves a valuation as a basis for capital-
ization on reorganization. The Conamission says:
In this connection, it shoidd be understood that the above
allowance for contractors' profit is not the profit of the svb*
contractors. The unit prices upon which Table III is based
include a profit to sub-contractors. The contractors' profit of
$2,370,000 allowed in Table IV is a general contractor's profit.
It is assumed that the company turns the work over to a gen-
eral contractor. He sublets various portions to sub-contractors,
Digitized by VjOOQ IC
§289] OvERHBAD Charges — Contractor's Profit 249
and everybody takes his profit. Now it is not neoessary nor
is it custcHnary for companies to follow such a practice throu^-
out all their construction work. It is customary to do so at
the start, but extensions are often made, new power houses
built and additional equipment purchased without the aid of
a general contractor. The company deals directly with the
8ub-CQntract(H« and eliminates the g^ieral contractor's profit.
Re Metropolitan Street Railway Reorganization, 3 P.
S. C. 1st D. (N. Y.) 113, 143, decided February 27, 1912,
also relates to capitalization upon reorganization. The
applicants asked that 7^% should be added to actual
cost as shown by vouchers as subcontractor's profits and
that to this amount there should also be added 10% for
general contractor's profit. The Commission rejected the
claim for subcontractor's profit as in this case purely
fictitious but allowed 10% for general contractor's profit
on certain items. The Commission says (at page 143) :
Net cost represents not only the cost of labor and materials
to the contractor who performs the woric, but all of his expen-
ses plus his profit. The only witness for the applicants who.
was familiar with the details of the estimate for net cost towards
the close of the proceeding asked that an additional allowance
of 7\^ per cent, upon certain items, totalmg |1,301,32S| should
be added as sub-contractors' profit-^this in addition to the
claim that a general contractor's profit of 10 per cent, should
be allowed upon the entire cost. It appeared that the appli-
cants have the actual cost for 70 or 80 per emit, of the items
to which this sub-contractors' profit of 7}^ per cent, applied,
and that the remaining 20 or 30 per cent, was computed from
records of actual cost. These costs cov«r whatever profit Uie
sub-contractor made. Consequently, the witness virtually
asked the Commission to allow a profit of T^ per cent, above
actual co9t as a profit that was never paid and for which there
is no justification. Naturally, the Commission, does not allow
this fictitious item.
The applicants claim that there should be allowed a general
Digitized by VjOOQ IC
250 Valuation K 289
contractor's profit of 10 per cent, upon all items except the
last three in Table II. Mr. Connette did not accept this esti-
mate as reasonable, maintaining that an allowance of 10 per
cent upon the estimated cost of removing obstructions and
repaying, rolling stock, tools, supplies, furniture, etc., was not
justified by experience, the records of the company or the esti-
mates of net cost. It will be noted that Tables II and III in-
dicate that the net cost for removing obstructions and repay-
ing over them was carried throughout without any addition
for contractor's profit, engineering, etc., and without any re-
duction for depreciation. The net cost is asserted to be suf-
ficiently liberal to cover all expenditures, direct and indirect,
and, as no depreciation has been deducted, it is considered
that the final amount at which it appears in Mr. Connette's
estimate of present value is abundant and perhaps larger than
should be allowed.
Mr. Connette also maintained, and it is believed properly
so, that a 10 per cent, profit upon the cost of rolling stock is
unjustified. Cars are ordinarily bought directly from the man-
ufacturers, who bear, all expenses connected with the designing,
construction and testing of the cars, and the prices charged
are sufficient to cover all such costs. The unit prices adopted
by Mr. Connette and Mr. Uebelacker, the witness for the ap^
plicants, include delivery in New York City, the cost of assem-
bling and other incidental expenses. The applicants have
presented no evidence to show that a general contractor's
profit of 10 per cent, above such unit prices has ever been paid,
and it would be considered wasteful and extravagant to pay a
general contractor a profit of nearly $1,000,000 — 10 per cent,
of net cost — ^for doing practically nothing. Indeed, companies
ordinarily buy direct from the manufacturers, and this prac-
tice is considered economical and prudent. The same may
be said regarding the other items upon which Mr. Connette
does not allow a general contractor's profit. A company needs
no middle man to negotiate for the purchase and delivery of
tools, supplies, fixtures, etc.
However, the question is not so much whether 10 per cent,
should be computed upon this or that item as whether the
Digitized by VjOOQ IC
§ 290] OvEBHEAD Chabges — Contbactob's Pboptt 251
total allowance for contractor's profit is reasonable. Mr. Con-
nette has estimated that $3,315,477 is entirely adequate upon
the basis of a net cost of S47;600,000, particularly in view of
the position taken upon other points. In the first place, as
has been pointed out, the unit prices are liberal and generally
above original cost. Secondly, they include a profit to the sub-
contractor. Thirdly, there is nothing in the record to indicate
that the company had recourse to a general contractor, even
upon a considerable portion of the work. It is not conmion
for a street railway company to employ a general contractor
at a profit of 10 per cent, for the construction of its entire sys-
tem from the early beginning to the date of appraisal. It is
not uncommon for a new company when starting to let a con-
tract for the erection of the initial plant to a construction com-
pany. If the latter is paid the cost of labor and materials, in-
cluding subcontractors' profit, plus 5 or 10 per cent, to cover its
profit and certain expenses, this contract would certainly be
considered a good one from its standpoint; but such a plan is not
generally followed throughout the life of an undertaking if there
is thrifty, progressive management. Additions and extensions
are commonly constructed and supervised by the operating com-
pany itself without the intervention of a general contractor, and
there is nothing in the record to show that this common practice
was not followed in the case of the Metropolitan system.
It is also, imdoubtedly true that if a general contract weie
let for the reproduction of the entire Metropolitan system,
the net cost of labor and materials would be less than that
computed by Mr. Connette, because an expenditure of nearly
$50,000,000 would make it possible for a general contractor
to secure unusually low {mces for all of the materials and sup-
plies which he would purchase — prices below those used as
the basis of the estimates.
In the opinion of the Commission, therefore, the allowance of
$3,300,000 for contractor's profit is generous.
§290. Contractor's profit— Valuation of Falmouth, Mass.,
water plant
The case of Town of Falmouth v. Falmouth Water Com-
Digitized by VjOOQ iC
252 Valuation [§ 290
pany, 180 Mass. 325, 62 N. E. 255, decided January 3,
1902, involves the valuation of a water plant for puipoaes
of municipal purchase. A statute gave the town the right
to take over the plant on payment of actual cost with
interest. The company had made a contract with a con-
tractor to build its works agreeing to pay the ''market
value at that time/' with a certain percentage added for
engineering expenses. During the progress of the work
the nuu*ket value of machinery and materials increased so
that the contract price paid by the con4>any was con-
sidecably greater than the actual cost to the contractor.
The town claimed that the actual cost which ihey were
to pay was the actual cost to the contractor plus only an
ordinary profit. Justice Loring said (at page 258) :
It is ai)gued by the town that this result amounts to sub-
stituting market value for actual cost, and actual cost excludes
everything in the nature of a {Nrofit. It is true that actual cost
excludes everything in the nature of a profit; but what is actual
cost to the company includes a profit to the contractor, just
as what is actual cost to the contractor includes a profit to
the merchants of whom he buys his materiaL The con^Miny
had to pay a profit to the contractor, as the contractor had to
pay a profit to the material men. The legislature no more in-
tended to open up the speculative question of the reasonable-
ness of the profit made by the contractor in his contract with
the company than that of the reasonableness of the profit made
by the material men in their contract with the contractor.
What it intended to do was to provide that the price to be
paid by the town should not depend \^xm opinions as to the
market value of the property when taken, but should be re*
strieted to what it had cost the company, with interest at 5
per cent. That it did not forbid the company in the first in-
stance fixing the price which it was to pay for the construc-
tion of its worics at the market value on completion^ if it thoo^it
it to be for the best interests of those interested in the cor-
poration to make a.oontract for its plant on that basis.
Digitized by VjOOQ IC
§291] Overhead Charges — Interest 253
S 291. Interest during constnictiofl.
In approved systems of untf orm accounts, interest dur-
ing construction is recognized as a proper capital charge.
It is customary to include an allowance f w interest dining
constructicm in appraisals for rate or public purchase
purposes. In the case of Brunswick and T. Water Dis-
trict V. Maine Water Company, 99 Me. a71, 69 Atl. 537,
542, decided December 14, 1904, the Supreme Judicial
Court of Maine in laying down rules to govern appraisers
in making a valuation of prop^y for purposes of munic-
ipal purcliase says in regard to interest during construc-
tion:
And a fair rate — ^usually the prevailing rate — of interest
upon the money invested in the plant during construction,
and before completion, is as much a part of the cost of con-
struction, as is the money itself which is expended for materials
and labor.
The case of the Long Branch Commission v. Tintem
Manor Water Company, 70 N. J. Eq. 71, 62 Atl. 474, 481,
decided November, 1905, involves the valuation of a water
plant for rate purposes. In this case the New Jersey Court
of Chancery allowed an item of $117,000 to cover in-
terest during construction on a total construction cost of
$1,270,000. Though court decisions considering interest
diuing construction are few the above and decisions
quoted m §§ 245, 246, 254, 292, 293, as well as the uniform
Itllowance for this item in the decisions of state conmiis-
sions, fully establish it as a proper charge. However, in
Lincoln Gas and Electric light Co. v. City of Lincoln
(see § 247) there is no allowance for interest during con-
struction, and in Cedar Rapids Gas light Company v.
Cedar Kapids (see § 240) this item is considered specula^
tive, and in the following instance the Appellate Division
of the Supreme Court of New York has disallowed interest
Digitized by VjOOQ IC
254 Valuation [§292
during construction. People ex rel. New York, Ontario
& Western Railway Company v. Shaw, 143 App, Div.
(N. Y.) 811, 128 N. Y. Supp. 177, decided March 8, 1911,
is a case involving the assessment of raib-oad right of
way in a New York tax district. Reproduction cost was
accepted as the measiu^ of value for the purposes of this
case. Judge Kellogg says (at page 813) :
We may say in passing that the item of interest was properly
rejected by the court as speculative in amount and unsupported
by the evidence. Of course, each dollar, as it was expended
in the railroad, ceased to produce income until the road could
be placed in operation. One witness thinks it would take eight-
een months to put the road in operation. That must be mere
guesswork. It is evident that about five miles of railroad may
be built in much less time, and that the time employed would
depend entirely upon the manner in which the work is pushed.
There is no substantial basis upon which the item of interest
may be computed.
§ 292. Interest— Minnesota Railroad Rate Case, 1911.
The case of Shepard v. Northern Pacific Railway Co.,
184 Fed. 765, 809, decided April 8, 1911, involves the
valuation of certain railroads for rate piuposes. Circuit
Judge Sanborn discusses allowance for interest during
construction as follows:
Exceptions were taken to the allowance of interest at 4 per
cent, per annum on the cost of the reproduction of the railroad
properties during one-half of the estimated times of their con-
struction. But the evidence is conclusive that moneys invested
for the purchase of rights of way for, and in the construction
of, railroads, ordinarily produce no net income during the period
of construction, that the amount of capital thus losing returns
is ordinarily equal to one-half of the cost of reproduction dur-
ing the entire period of construction, or to the entire cost dur-
ing one-half of that period. There is no doubt that interest
at a fair rate on the capital invested in materials and labor
Digitized by VjOOQ IC
§293] OvEBHEAD Charges — Interest 255
that remams idle during construction is as much a part of
the cost of constructing or reproducing a railroad as is the
money paid for those materials or that labor. Brunswick
Water District v, Maine Water Company, 99 Me. 371, 59 Atl.
537, 542. Mr. Morgan, the engineer and witness for the de-
fendants, allowed in his report to the Conmiission, and verifies
the justice of an allowance, of 4 per cent, per annum during
one-half of the period of construction; but the amounts he
allowed were less than those found by the master, because
his estimates of the cost of reproduction and of the times req-
uisite for construction were less. The weight of the testimony
on this subject, however, sustains lai^r amounts than those
fixed by Mr. Morgan or the master, and there was no error
against the defendants in the latter's finding and allowance
of the item here under consideration in either of the cases in
hand.
§ 293. Interest— Oklahoma Telephone Rate Case, 1911.
The case of Pioneer Telephone and Telegraph Company
V. Westenhaver, involves the valuation of a telephone
plant for rate purposes. In regard to interest during con-
struction the Oklahoma Supreme Court says: ^
Item No. 3, disallowed by the Conmiission, is for interest
on the capital invested during the period of construction. . . .
It is a matter within the observation and knowledge of all
that a pl^t, the cost of whose physical units put together
into a completed plant approximates $100,000, cannot be con-
structed instantly. It requires time to assemble the physical
properties, and still a greater length of time to put those
units into place, where they may be used to render service.
During this period, the capital invested must of necessity be
idle, and no income can be derived therefrom. When the con-
struction of the plant is completed, no willing seller, who is
not forced to sell, would take for his plant the cost of the phys-
ical units and the cost of the labor in the construction, because
* Pioneer Telephone and Tel^raph Company v, WeBtenhaver, 118 Pac.
364, 357, decided January 10, 1011.
Digitized by VjOOQ IC
2S6 Valuation {§ 294
the plant has cost him in addition thereto the use of the capi-
tal, or a certain part thereof, invested in the physical properties
during the time of construction. A willing buyer could afford
to pay, and would pay, more than the actual cost of labor and
material, assuming that the plant has been economically con-
structed, because such cost would not represent the total ex-
penditures the purchaser would have to make in order to con-
struct the plant himself. In addition to such expenditures,
he would have to expend the earnings of his capital during
the period of construction. No case has been cited, and in our
investigation we have found no case, involving this question,
where a reasonable amount has not been considered and al-
lowed for loss of interest during construction as part of the
cost of construction.
§ 294. Interest— Wisconsin Railroad Commission.
In the case of State Journal Printing Co. v. Madison
Gas and Electrio Company, 4 W. R. C. R. 501, 541, de-
cided March 8, 1910, the Wisconsin Railroad Commission
discusses interest during construction at considerable
length:
The cost of interest during construction was the subject of
much testimony. The staff of the Commission used 3 per cent
under the assumption of one-year construction, but changed
it to 4 per cent, because it was estimated that the construc-
tion might require more than one open season. Interest at
3 per cent, under a one-year construction period would be at
the rate of 6 per cent for the whole amount of capital during
half of the period of construction. . i .
.... The element of interest during construction, theo-
retically, is the current rate for the use of each item of the
outlays during the time which intervenes between each such
outlay and the date of the completion of the plant up to the
point of operation. The sum of these charges, however,
is the minimum amount that should be allowed as interest
during construction. As a practical question, it would seem
inevitable that the actual interest cost might, in some cases.
Digitized by VjOOQ iC
§295] Overhead Charges — Interest 267
be even greater than this, for the money might have to be
provided in advance of the installation of the integral parts
of the plant. Land has to be provided, franchises secured,
organization effected, bonds marketed and much expense in-
curred at the start. The opinion, however, seems to prevail
that all the money should be figured as under interest for half
the construction period. This is equivalent to an assumption
that the expenditures involved in construction would follow
a uniform curve from the commencement of construction to
completion thereof to the px)int of operation, and that money
could be borrowed just as needed or, if borrowed all at the
beginning, could be placed at interest at the rate paid foriihe
whole amoimt and withdrawn as fast as needed in the work
of construction. . . .
But whatever the interest rate may be in any particular
case, it is likely to be considerably higher for the original plant
than for subsequent extensions to it. This is due partly to
improvements in the credit of the plant, and partly to the
fact that for a plant that is in operation and earning money
there are many ways in which the income and the working
capital can temporarily be so used as to keep down the inter-
est chaises for new additions without materially affecting
either the income or operating expenses of the plant.
§ 296. Interest— St. Louis Public Service Commission, 1911.
In the valuation for rate purposes contained in a report
of the St. Louis Public Service Conunission to the Munic-
ipal Assembly on rates for electric light and power,
February 17, 1911, the Commission allowed $725,780 for
interest during construction on construction of physical
properties. The entire cost on which this allowance was
made was $14,872,061. The company asked for an in-
terest allowance of $2,490,749. The Commission states
that the wide difference between its figures and those of
the company was the result of the company's assuming a
hypothetical set of conditions while the Commission has
aimed to consider tb? wtuftl conijitipn^ under which the
17
Digitized by VjOOQ iC
258 Valuation [§ 296
work was carried on. The Commission says (Report,
page 50) :
As a very marked illustration of the difference in results
caused by adopting the Commission's method of considering
actual conditions instead of the hypothetical conditions as-
sumed by the Company, we would caU attention to the item
of interest during construction on real estate. Under the as-
sumed conditions as used under the theory of Cost of Repro-
duction New, the present value of the real estate as estimated
by the Compaay was taken as a basis, and to this was added
compound interest for a number of years to come. It is evi-
dent that if such a method of valuation were allowed, the
present consumer would be required to pay now not merely
on a high present value, but even on a still higher future value.
The wide difference between the Company's and the Com-
mission's figures on this item is due to the Commission's be-
lief that in dealing with interest during construction the Com-
pany is ^Tong in theory, that its assumptions are not in ac-
cordance with the real facts in the case, and that the results
arrived at are imreasonable.
As indicated above, the Commission's interest allowance
on land was based on the original cost of the land and not
on its present value. The Commission allowed 6% in-
terest for the mean time over which the expenditures were
spread before operation began. The meantime is as-
sumed to be one-half of the actual period of construction
except in the case of the real estate.
§ 296. Interest— New York PubUc Service Commission, First
District, 1911.
In the case of Mayhew v. Kings County Lighting Com-
pany, 2 P. S. C. 1st D. (N. Y.) — , decided October 20,
1911, the question of interest during construction is dis-
cussed by Commissioner Maltbie:
As to interest and taxes, a close estimate can be made. Not
Digitized by VjOOQ iC
§296] Overhead Chabges — Interest 259
more than eighteen months would be required to construct
so much of the plant as might be necessary for the beginning
of operation according to the testimony of the engineers of
the company. This does not mean that the whole undertaking
with all its lines, from the very beginning to the end, would
be built in that period, but that the equated period would not
exceed that time. The period of construction of the initial unit
practically determines the limit. As soon as an operating imit
and a few lines are completed, operation of that portion may
begin, and when operation may begin the construction period
for that portion ends, and when the construction period ends,
interest and taxes may no longer be charged to construction
cost. They then become charges against income and should
be paid out of operating income. As other lines are built and
additions made, it is proper to charge interest upon them to
capital, but only until the property is ready for use, provided
good management has been had throughout. Thus the equated
period becomes not the time from the initiation of the idea to the
completion of the last remote branch (that may be many years
or decades), but the weighted average time for the completion
of each operating unit, due allowance being made for the cost
of such imit. A piu*e average is not correct, for the amount
of interest to be paid has relation not merely to the period
but to the cost of the work. In this case the equated period
of construction would not exceed eighteen months. The rate
of interest would be about six per cent, per annum, and the
taxes would be small.
It is obvious that the whole cost would not bear interest for
the equated period, as funds would be provided only as needed.
Certain apparatus would be purchased just before the beginning
of operation, and therefore it would not be imfaar to the com-
pany to compute interest for the full period upon one-half of
reproduction cost, plus the cost of land and other preliminary
and development expenses. Upon this basis, $120,000 would
be ample.
This subject is also discussed as related to street railway
construction in Re Metropolitan Street Railway Reor-
Digitized by VjOOQ IC
260 Valuation [§ 297
ganization, 3 P. S. C. 1st D. (N. Y.) 113, 173, decided
February 27, 1912.
§ 297. Interest— State railroad appraisals.
In the Minnesota railroad appraisal of 1908, interest
during construction was allowed at 4% per annum for
one-half of the estimated time required to build the re-
spective lines, which according to their mileage, varied
from one to eight years. Thus the total allowance was
from 2% to 16% (see § 252). In the Michigan raiboad
appraisal of 1900, the rate of interest was fixed at 6% per
annum, the construction period at one year, and interest
was allowed for one^ialf of the estimated construction
period. Accordingly, there was a uniform allowance of
3% for interest diuing construction. In speaking of the
Michigan allowance, Henry Earle Riggs says: ^
The corporate history of the Ann Arbor Bailroad, in Michi-
gan, 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 imder con-
struction 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 suflB-
cient 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.
In the Wisconsin railroad appraisal of 1903, the allowance
for interest during construction was also 3% (see § 261).
^ See his paper on Valuation, in Proceedings Americaa Society of CivU
Engineers, November 1910, p. 1512.
Digitized by VjOOQ IC
§298] Overhead Charges— Pbomotion 261
In the Wafihington railroad appraisal of 1908, the allow-
ance was from 3% to 7}4% (see § 258). In the South
Dakota railroad appraisal of 1910 the allowance was 3%
(see § 257).
§ 298. Interest— Massachusetts appraisal of N. T., N. H. &
H. R. R., 1911.
George F. Swain in his appraisal of the New York, New
Haven and Hartford Railroad for purposes of capitaliza-
tion discusses interest during construction as follows: ^^
IrUeresi and Commisaians. — This item covers interest on the
capital required prior to the opening of the road. It is based
on an assumed rate of 6 per cent, per annimi, and the further
assumption that it will take foiu* years to complete the road,
making an average charge of 6 per cent, for two years on the
entire cost, including the present overhead charges, but not
including equipment, which would be the last thing purchased.
This is the same figure which was used by Price, Waterhouse
&Co.
With reference to this charge, it must be remembered that
the rate of interest to be assumed is not that which the New
York, New Haven & Hartford Railroad Company to-day
would have to pay for money. It is, on the contrary, the rate
which a new company intending to build a road would have
to estimate upon. On this basis, 6 per cent, is certainly not
too high. This item also includes the legitimate charges of
marketing the securities, not including, however, any discount
on those securities, except so much as may be the legitimate
commission to the bankers for the expense of marketing.
§ 299. Promotion and organization.
Most appraisals contain a small percentage to cover
*> Report to the Joint Board on the validation of assets and liabilities
of the New York, New Haven and Hartford Railroad under Chapter 652,
Acts of 1910y by George F. Swain, Engineer in Charge. Published in Re-
port of the Massachusetts Jdnt Commission on the New York, New Haven
A Hartford Raihx>ad Company, Febroary 15, 1911, pp. 51, S7.
Digitized by VjOOQ IC
262 Valuation [§ 209
legal and other expenses connected with the organization
of the company. In some cases this is included in an
allowance for general and legal expenses. A few ap-
praisals in addition to making provision for company
organization include a substantiid allowance for promo-
tion. The New York Public Service Conmiission for the
First District has included such an allowance imder the
term "preliminary and development'* expenses (see also
§ 302), In re Queens Borough Gas and Electric Company,
2 P. S. C. 1st D. (N. Y.) — , decided June 23, 1911, Com-
missioner Maltbie in delivering the opinion says:
There are certain expenses connected with every under-
taking which are not represented by physical property but
which must be incurred before the plant is operated. These
relate to the initial promotion of the scheme and the organi-
zation of the company. Investors must be interested, lawyers
and engineers must be consulted, and franchises and permits
must be secured.
In the case of Cedar Rapids Gaslight Company v. Cedar
Rapids, 144 la. 426, 120 N. W. 966, 970, decided May 4,
1909, involving the valuation of a gas plant for rate pur-
poses, the Iowa Supreme Court ruled against an allowance
either for organization or promotion: **
Nothing can be allowed for the promotion and organization
of the company, for it is immaterial by whom the plant may
be owned in estimating its value.
In Knoxville v. Water Company *' the Supreme Court of
the United States refers to but does not decide this quea-
*'The company carried this case to the Supreme Ck>urt of the United
States and the decision of the state court was sustained. (Cedar Rapids
Gaslight Company v. Cedar. Rapids, 223 U. S. 655, decided March 11,,
1912.) Justice Holmes in delivering the opinion of the court does not,
however, refer in any way to the question of promotion cost.
»• Knoxville v. Water Company, 212 U. S. 1, 29 Sup. Ct 148, 63 L. «d.
371, January 4, 1909.
Digitized by VjOOQ iC
§300] Overhead CHARQEd— Promotion 263
tion. In this case the court below had included $10,000
on a total cost of $608,000 to cover ''organization, pro-
motion, etc," Justice Moody says "we express no opinion
as to the propriety of including" this item "but leave
that question to be considered when it necessarily arises."
"We assimie, without deciding that" this item was
"properly added in this case." The above seem to be the
only court decisions that refer to this question. Promo-
tion considered as the cost of prospecting and securing the
financial backing necessary to the initiation of a new
enterprise does not appear to have been allowed for in
the various appraisals considered, except in those of the
New York Public Service Conunissions as shown in
§§ 301, 302.
§ 300. Promotion— St. Louis PubUc Service Commission,
1911.
The valuation for rate piuposes contained in a report of
the St. Louis Public Service Conamission to the Municipal
Assembly on rates for electric light and power, Febru-
ary 17, 1911, contains an allowance of $125,000 for ex-
pense of organization and of $32,944 for interest on the
organization expense. In this case the total estimated
cost of organization and construction including overhead
charge was $15,030,505. The Commission says (Report,
pages 31, 32):
In addition to the value of its physical property, the Company
is entitled to have recognized as part of its assets on which it
is entitled to earn a return, such amounts of money as have
been expended by way of fees paid to the state, legal expenses,
etc., in the formation of the corporation and the legitimate
expenses of obtaining the franchise by the corporation, if any;
but expenses preliminary to the organization of the corporation
in prospecting the field, interesting prospective stockholders,
and promoters' profits are not, in the opinion of the Commission,
Digitized by VjOOQ IC
264 Valuation [§ 301
under the laws of this State, prq;)er items for consideration
in this connection.
The Company claims for this ITOO^OOO, and presented ex-
pert testimony in support of its claim, based on the theory
of cost of reproduction new of the Company, but its witnesses
included in this item many elements of ejcpense which do not
seem applicable to this case, or indeed proper elements of
charge as part of this item. The amount of the Company's
claim is fixed arbitrarily at three and one-half per cent, of its
valuation of all the balance of its permanent investment. We
fail to see any relation between this item of expense and the
value of the Company's investment, and no reason was given
for thus determining its amount.
It appears to be simply an arbitrary method of arriving at
the amount of this expense. We consider that an allowance
of $125,500 is ample to cover this item. Interest is allowed
specifically upoa this item, inaanueh as such expenditures
generally precede the operation of the plant by a considerable
period of time.
In this case the company also requested an allowance of
$428,509 for time and expense of permanent organization
force during construction peripd. The Conmiission disal-
lowed this item, stating that (Report, page 33) '^ As a mat-
ter of fact, as is often the case, the operating officials and
the engineering officials, were to a great extent identical,
and in making an allowance of 5 per cent for engineering
on all the items of construction, the Commission considers
that it has made allowance to cover the cost of the time
of officials paid for as operating expenses but really de-
voted to engineering/'
§ 301. Promotion— New York Public Service Commission*
Second Districti 1908.
The New York Public Service Commission, Second
District, in the matter of the application of the Rochester,
Corning, Elmira Traction Company, 1 P. S. C. 2d D. (N.
Digitized by VjOOQ IC
§301] Overhead Charges— Promotion 265
Y.) 166, decided March 30, 1908, lays down the principle
that in determining the amount of securities that may be
issued by a new enterprise a fair allowance will be made for
services in promoting the organization of the enterprise.
Such allowance will be placed upon a basis of just pay-
ment for valuable and indispensable services. Chairman
Stevens in his opinion says (at page 177):
Another subject of great interest and importance is the
compensation, if any, to which the promoters of the enter-
prise should be entitled for their services. Promotion has been
so extensively abused and has been so universally used as a
cover for abuses in capitalization that it has come to be re-
garded as a term of reproach and as a device to work schemes
of robbery upon the investing public. No reason is apparent
why this should necessarily be so. The honest services of a
capable promoter are indispensable to the flotation of every
comprehensive and far-reaching scheme of development in the
railroad world, or elsewhere. A clear vision to see opportuni-
ties, ability to demonstrate them to others, and energy to
push to completion works untried but of great moment, are
indispensable to material development and should be fairly
and even liberally rewarded by the public which receives the
benefit of those works. Such rewards, however, should be
put upon a clear basis of business principle, should be of suffi-
cient magnitude to encourage rather than discourage enter-
prise, and should not be so great as to make an exorbitant
demand which is perpetual in its nature, upon the conmiunity
to be served. They are to be treated simply as just payments
for services performed for the corporation, which services
are valuable and in many cases even indispensable. Such serv-
ices should be paid for upon the basis of what they are fairly
worth, having regard to all the circimistances of the case.
In the case under consideration the CJommission fixed
the allowance for promotion at 5% on the estimated cost
of the railway.
Digitized by VjOOQ IC
266 Valuation [§302
§302. Promotion— New York Public Service Commission,
First District, 1912.
The New York Public Service Commission for the
First District \ias included an allowance for costs of pro-
motion in various rate and capitalization cases. Be
Metropolitan Street Railway Company Reorganization,
3 P. S. C, 1st D. (N. Y.) 113, 165, decided February 27,
1912, relates to capitalization after reorganization. The
Commission discusses development expense as follows:
There are certain expenses connected with every under-
taking which are not represented by physical property, but
which must be incurred before the undertaking is operated.
Lawyers and engineers must be consulted. Permits must be
secured. Interest and taxes dimng the period of construction
must be paid, and as there are no earnings, they must be in-
cluded as part of the cost of the undertaking. There are
also other expenses connected with the experimental and trial
operation of machinery and the adjustment of various parts
of the enterprise, which antedate operation.
Ordinarily, one would expect that the company itself would
have data upon which to base an estimate of a reasonable al-
lowance for these items; but no such data have been produced.
In other cases decided by the Commission, when an estimate
has been necessary, the amounts allowed for promotion of the
original scheme, the securing of rights and permits, experi-
mental operation, adjustment of system, preliminary legal
fees and technical ad\dce have varied from 5^ to 8 per cent,
of the reproduction cost of the plant plus the cost of the land.
These were smaU plants compiured with the Metropolitan sys-
tem, and as many expenses are nearly the same in amount
regardless of the size of the company, a percentage basis is
not the correct standard. Seven per cent of the cost to re-
produce the physical property in this case would be nearly
$5,000,000.
The whole question of preliminary and development charges
is so bound up with another subject, to which much attention
was given — "going value" or "going concern value" — ^that
Digitized by VjOOQ iC
§302] OvEBHEAD Charqes— Promotion 267
the two cannot well be separated, and it is necessary to consider
the testimony upon this subject before a final estimate is
made. . . .
After considering all of the opinions and peculiar facts re-
lating to this system it is the opinion of the CJommission that
a siun of from $5j0O0flO0 to HfiOOfiOO for development ex-
penses in addition to the amounts already allowed and in addition
to the payments to be made out of the fund of f7jS00fl00 is ample
to cover promotion expenses, preliminary legal fees and tech-
nical services, adjustment of plant and all other elements
which should be included.
Digitized by VjOOQ iC
CHAPTER XIII
Discount on Bonds
§320. Definition.
321. Treatment in uniform systems of accounts.
322. Treatment in connection with capitalization.
323. Treatment in pubtic purchase cases.
324. Cleveland and Chicago street railway settlements.
325. New York subway contract.
326. State railroad appraisals.
327. Valuation for rate purposes.
328. Washington Railroad Commission — Rate Case.
329. Wisconsin Railroad Commission — Rate Cases.
330. Columbus, Ohio, Electricity Rate Case, 1906.
331. Lincohi, Neb., Gas Rate Case, 1909.
332. Minnesota Railroad Rate Cases, 1910.
333. Summary — Discount in Rate Cases.
§320. Definition.
Two elements may be present in bond discount:
(1) brokerage, (2) deferred interest. Brokerage has been
defined as *'the expense necessary to be paid a reputable
broker for making a full and complete investigation into
the cost and prospects of an inviting public service enter-
prise and a reasonable compensation for inducing his
clientage to invest in well secured bonds and securities of
such corporation." If bonds are sold to a broker at 96
who takes them with the expectation of being able to dis-
pose of them to the public at 100, the 5% discount is
purely a brokerage charge. If, however, the bonds are
sold to a broker at 85 who in turn disposes of them to
the public at 90, there is in addition to the brokerage
charge of 5% a deferred interest charge of 10%, making
a total discount of 15%. But both brokerage and deferred
interest or discount proper are a part of the amount that
[268]
Digitized by VjOOQ IC
§ 321] Discount on Bonds 269
the tompany must pay on its borrowed capital. They
should both be paid out of earnings during the term of the
bonds. Payment for the use of money of whatever kind
is in the nature of an interest payment and is most properly
converted into and treated as an annual interest charge.
Capital secured by the issue of 50 year 5% semiannual
bonds at 84.2 actually costs the company 6% per year.
§ 321. Treatment in uniform systems of accounts.
The uniform systems of accounts adopted by the New
York Public Service Commissions require that all dis-
counts and commissions and all expense connected with
the sale of bonds shall be charged to a suspense account
and not to capital, and shall be amortized during the term
of the bonds. The rule of the Interstate Commerce Com-
mission for steam roads allows a fair brokerage commission
to pay "for services rendered in the sale of bonds" but
not ordinary discount, to be charged to capital. But the
more recent rule of the Interstate Conmierce Commission
in relation to accounts of electric railways forbids the
charging of either discounts or commissions to construc-
tion. The Wisconsin uniform systems of accoimts allow
discount to be charged to capital. No imiform accounting
rules are prescribed by the Massachusetts commissions.
The system of accounts voluntarily adopted by the
American Telegraph and Telephone Company excludes
discount from the construction account. The uniform
accounts for systems of water supply adopted in 1911 by
a conference consisting of representatives of the United
States Bureau of the Census, American Water Works
Association, New England Water Works Association,
American Association of Public Accountants, Ohio
Biireau of Uniform Public Accoimting and others, and
published by United States Bureau of the Census, con-
taina the following in relation to amortization of bond
Digitized by VjOOQ IC
270 Valuation [§ 321
discoiint and development and promotion expenses (at
page 28) :
Intangible assets in the nature of capitalized costs of pre-
liminary operations, discounts on outstanding stock, and costs
of promotion, should be amortized in equal payments for such
number of years as the management finds is consistent with
the best business administration.
The systems of imiform accounts prescribed by the
Public Service Conamission of Maryland under date of
June 12, 1911, to govern electrical corporations, gas cor-
porations, street railway corporations, telegraph and tele-
phone companies and water companies contain uniform
provisions forbidding the charging of discount on securi-
ties to capital account and requiring the amortization of
discount during the term of the bond. These uniform
provisions are as follows;
THacounts upon securities. Discounts on securities or other
commercial paper issued in payment for capital are to be pro-
vided for in other accounts and must in no case be charged to
capital accounts.
Extinguishment of discount on securities. Charge to this ac-
count at the close of the year the proportion of the unextin-
guished discount on securities applicable to the period. This
proportion shall be such an amount as will completely wipe
out the discount on the debt during the interval between issue
and maturity of the same. The corporation may, if it so desire,
earlier wipe out such discount by charging all or any part thereof
to the "Corporate Surplus or Deficit" account.
In the past corporations have quite generally charged
discount on bonds to construction cost, but in view of the
stand taken against this policy by the leading authorities
on accounting and the action of the Interstate Commerce
Conmiission and various public service conunissions in
excluding it from that account and the action of cer*
Digitized by VjOOQ iC
§ 322] Discount on Bonds 271
tain corporations in voluntarily adopting the same policy^
it seems that the amortization of bond discount will be-
come the standard practice.
§ 322. Treatment in connection witii capitalization.
The national commission appointed to investigate rail-
road capitalization in its report made in 1911 recommends
the amortization of discount on bonds: ^
It seems to be generally agreed that no limitation should
be placed on the price at which bonds can be sold, but any
discount should be cancelled or amortized during the life of
the bonds by the appropriation each year, out of annual in-
come or surplus accumulated after the issue of the bonds,
of not less than the proportionate amount of the discount.
Re Amortization Accounts of Third Avenue Railway
Co., 3 P. S. C. 1st D. (N. Y.) 51, decided February 3,
1912, is a case involving the approval of issue of securities
after reorganization, by the New York Public Service
Conmoission for the First District. The existing statute
as interpreted by the Court of Appeals permitted the
reorganized company to issue new securities up to the
amount of the old capitalization. The Commission,
however, in approving such issue ordered the company
to provide during the term of the bonds for the amortiza-
tion of the difference between the actual value of its
property and its total capitalization. The Conmiission
argued that this difference was in the nature of bond dis-
count. Conmoissioner Maltbie said (at pages 55-57) :
The requirement that discounts shall be amortized is a gen-
erally recognized principle. The unanimous conclusion of the
Railroad Securities Commission in its recent report to the
President of the United States was to this effect. . . ,
The Public Service Commission has approved the issue of
v
^ Report of the Ruilroad Securities CommisBion, November^ 1911, p. 28.
Digitized by VjOOQ IC
272 Valtjation [§ 322
approximately $100,000,000 par value of bonds exclusive of
the securities of the reorganized Third Avenue and Metro-
politan Street Railway companies. Probably 90 per cent, of
these securities have been 3J^, 4 or 5 per cent, bonds, issued
at less than their par value^ It has been the invariable practice
of the Commission to require the difference between the cash
proceeds of the bonds and their par value to be treated the
same as bank discount or interest psdd in advance and to be
amortized within the term of the obligations. The propriety
of this requirement has never been contested by any of the
corporations affected. This procedure is in accordance with
well established principles of accounting and with the rules
of accounting prescribed by the Interstate Commerce Com-
mission and the two Public Service Commissions of New York
and other regulatory bodies. . . .
The excess of liabilities over assets is thus seen to be nearly
$30,000,000. If the revisions in current liabilities and assets
requested at a former hearing were allowed, the excess would
be nearly $29,000,000. Even assuming that the current liabili-
ties unfunded would be paid out of operating expenses, there
would still remain an excess of upwards of $26,000,000. . . .
In order that this difference, which is in the nature of a dis-
count upon securities, may be eliminated during the life of
the bonds, it is necessary that an amount should be set aside
annually out of income before dividends and interest on the
income bonds may properly be paid. It is evident that the an-
nual amount is determined by the rate at which the fund will
accumulate. It is certainly not less than 4 per cent., and upon
this basis the annual payment would be $180,000 plus 4 per
cent, upon previous payments and accxunulations. If this
course is followed, the company in 1960 will have a fund which,
together with its other property, assuming it to be maintained
as above stated, will be equivalent to the par value of the se-
curities then outstanding.
In Massachusetts the practice of the Board of Gas and
Electric Light Conmiissioners in authorizing new bond
issues is to fix the term and interest rate and prescribe
Digitized by VjOOQ iC
§322] Discount on Bonds 273
that the bonds shall not be sold at less than par and ac-
crued interest. The Massachusetts Railroad Conunission
on the other hand sometimes allows the issue of bonds at
a discount. Chapter 536 of the Laws of 1910 provides
that whenever the Conmiission authorizes the issue of
bonds at a discoimt, it may in its order of approval or at
any time thereafter require the company "to establish a
sinking fund estimated to realize at the maturity of said
bonds a sum equal to the difference between the amoimt
or amounts for which such bonds were authorized or ap-
provedy and the face value of the bonds so authorized or
approved therefor, and may designate some Massachu-
setts trust company as trustee and custodian of such
fund, and may from time to time change such trustee."
It is also provided that "the provisions of any agreement
relative to said sinking fund made between the street rail-
way company and the trust company selected as such
trustee, shall be submitted to said Boiuxl and shall not be
valid until approved by it." * George F. Swain, engineer
in charge of the valuation of the property of the New
York, New Haven and Hartford Railroad Company for
the purpose of testing the existing capitalization, says in
his official report (at page 88) : '
It is recognized that discoimt on securities is not a proper
charge to capital, but is simply an adjustment of interest, for
if the securities can be sold at all, the rate of interest which
they cariy may be made such that they would sell at par.
* An Older in relation to the establishment of a sinking fund for bond
discount is contained in the Commission's order of September 12, 1910, on
the petition of the Shelbume Falls and Colrain Street Railway Company,
42nd Annual Report of the Board of Railroad Commissioners, p. 117.
* Report to the Joint Board on the validation of assets and liabilities of
the New Yock, New Haven and Hartford Railroad under Chapter 652,
Aets of 1910, by George F. Swain, Engineer in Charge. Published in Report
of the Massachusetts Joint Commission on the New York, New Haven
ft Hartford Railroad Company, February 15, 1911, pp. 51-154.
18
Digitized by VjOOQ IC
274 Valuation [§ 323
§ 323. Treatment in public purchase cases.
No coTirt or commission decisions have been found that
include bond discount or brokerage in valuations for
public purchase. The decisions in purchase and condem-
nation cases have made no reference whatever to bond
discount as a possible element of cost or value. Discount
is fundamentally not an element of investment but of the
apportionment of returns on the investment. The manner
in which profits are apportioned between the partners in
an enterprise does not affect the value of the enterprise.
The manner in which the profits of a public utility plant
are apportioned between bondholders and stockholders
does not affect the intrinsic worth of the plant.
§ 324. Cleveland and Chicago street railway settlements.
The Cleveland street railway settlement of 1909 fixes
a valuation of the property of the Cleveland Street Rail-
way Company which forms the basis for adjustment of
rates and for possible municipal purchase. The valuation
which was the original basis of this settlement was made
by Judge Tayler, acting as arbitrator, December 17, 1909,
and includes no allowance for brokerage or discount. The
settlement ordinance contemplates a rehabilitation of the
existing lines and provides for municipal purchase at any
time on payment of the above original valuation and the
par value of any stock or bonds issued to pay for the con-
struction of additions to property plus a bonus of 10%.
The stock, however, may not be issued at less than par
and the bonds may only be issued at less than par with
the consent of the city.
The valuations made during the period 1906 to 1910
for the purposes of the Chicago Street Railway Settle-
ment include an item of 10% on the total estimated cost
of reproduction to cover legal expenses, interest during
construction, contingencies and brokerage. The settle-
Digitized by VjOOQ iC
§325] Discount on Bonds 275
ment ordinances, 1907-1910, provide for municipal pur-
chase at any time at the above stipulated valuations plus
the cost of all additions to the property. To the actual
cost of such additions there is to be added 10% ''as a fair
and proper allowance to the company for conducting
the said work and furnishing the said equipment" and
6% "for its services in procuring funds therefor, includ-
ing brokerage/'
§ 326. New York subway contract.
The question of including bond discount in the proposed
terms of purchase to be inserted in franchises for the con-
struction and operation of rapid transit railroads in New
York City is discussed at length in the "Report of a Com-
mittee of the Board of Estimate and Apportionment and
of the Public Service Conunission for the First District
with relation to pending proposals for rapid transit lines,"
June 5, 1911. The report opposed the contention of one
of the companies that bond discount was a legitimate part
of "actual cost" (pages 81, 84):
It is not maintained that the par value of bonds may not
exceed the amount of money which a company must raise.
It is conceivable that it would be more advantageous to a
company to issue a 4% bond and sell it at a discoifnt than
to issue a 5% bond and sell it at par. . . . But if such a course
were followed, the City ought not to be compelled as a direct
result to pay many millions more than it otherwise would.
It is self-evident that neither the cash investment nor the
value of the property has been increased by the issuance of
a 4% bond as compared with one bearing a higher rate of in-
terest. . . . Discount on bonds is practically interest in another
form and cannot properly be considered as part of the cost of
the property.
S 82t6. State railroad appraisals.
Neither bond discount nor brokerage has been consid-
Digitized by VjOOQ IC
276 Valuation [§ 327
ered in the general state railroad appraisals made by
Texas subsequent to 1893, by Michigan in 1900 and 1902,
by Wisconsin in 1903, by Minnesota in 1907 and by South
Dakota in 1910. The appraisal by Texas was for the pur-
pose of regulating capitalization, by Michigan and Wis-
consin for tax purposes and by Minnesota and South
Dakota for the regulation of rates. Engineer Henry Earle
Riggs, connected with the Michigan appraisal, states that
discount on bonds was not included as it was not con-
sidered '*a proper capital charge but rather an adjustment
of the interest rate to the existing market condition and
chargeable to interest account and not capital." *
In the Washington railroad appraisal, Mr. Gillette,
Engineer for the Washington Railroad Commission, in-
cluded in his estimate of the original cost of the Northern
Pacific Railway an item of $7,173,190 for interest dur-
ing construction and bond discount. It is stated that of
the first $22,400,000 expended by the road, more than
$6,900,000 was charged to interest and discount, or nearly
27% of the total. However, in his estimate of cost-of-
reproduction-new of the same road there is no allowance
for bond discount.*
§ 327. Valuation for rate purposes.
As regards a valuation for rate purposes the argument
against the inclusion of bond discoimt is convincingly
stated in the ''Report of the Committee on railroad taxes
and plans for ascertaining the fair value of railroad prop-
erty'' submitted to the twenty-third annual convention
of the National Association of Railway Commissioners,
October, 1911 (Proceedings, page 149):
* See luB paper on Valuation in Proceedings American Society of Civil
Engineers, November 1910, p. 1417.
* See Second and Third Annual Report of the Washington Raihoad Com-
miasion, 1907-1906.
Digitized by VjOOQ IC
§ 328] Discount on Bonds 277
Whether bonds are issued at a premium or a discoimt, it
]s the actual amoimt in money received therefrom that is of
importance in fixing value for rate purposes. The same may
be said of stock issued at a premium. It is sometimes argued
that because bonds are allowed to be issued below par that
discount or brokerage is a proper charge in estimating cost
and fair value for rate piuposes. . . . Payment for the use of
money of whatever kind is in the nature of an interest pay-
ment and is most properly converted into and treated as an
annual interest charge. ... In a rate case it is not necessary
to consider the manner in which the company chooses to pay
this annual charge. It makes no difference for this purpose
whether the company may have issued 6 per cent, bonds at
par or 5 per cent bonds at 84.2. The real payment was 6 per cent
in either case. In a rate case the rate of return allowed the
company on its investment must be at least equal to the real,
as distinct from the nominal, rate paid by the company for
the use of borrowed money. And having provided for necessary
brokerage and discount in the rate of return allowed, it is clear
that discount on bonds should not be added to the valuation
for rate purposes as that would result in a double allowance
for discount.
In a rate case the fair rate of return allowed on the fair
value of the property must at least equal the interest rate
on bonds necessarily issued plus the amortization rate
for the amortization of the discount upon such bonds.
Bond discount need only be considered therefore in so far
as it may throw some light on the question of what con-
stitutes under the circumstances of the case a fair rate ai
return. It has, however, nothing whatever to do with
actual cost or with reproduction cost or with fair value,
either for rate purposes or for public purchase.
§ 328. Washington RaOioad Commission— Rate Case.
In Paulhamus v. The Puget Sound Mectric Railway,
February 26, 1910, the Washington Railroad Commission
Digitized by VjOOQ iC
278 Valuation [§ 329
considered very carefully the question of bond discount.
The company asked for an allowance of $420,500 in an
estimate of cost of reproduction to cover bond discount.
The Conunission allowed, however, but $150,273, which
was 5% of 75% of the cost of reproduction. The follow-
ing is a digest of the opinion:
The expense necessary to be paid a reputable broker for
making a full and complete investigation into the cost and
prospects of an inviting public service enterprise and a rea-
sonable compensation for inducing his clientage to invest in
well-secured bonds and securities of such corporation is a
legitimate and proper item of expense. Well-secured bonds
are such as have behind them the guarantee of a solvent in-
dependent road or where a substantial amount of the invest-
ment is procured independent of the mortgage bonds. Where
all the investment, including costs of organization and pre-
liminary siuveys, are derived from the sale of bonds, the loan
is not a financial business transaction, but is a financial specu-
lation. Discount paid under such circumstances is not a proper
item to be considered in valuing the property. Heldf under
the facts in this case, that 5 per cent, of 75 per cent, of the cost
of reproducing the road is a proper and ample sum to cover
the costs of financing the enterprise.
In subsequent valuations made by the Washington (Com-
mission the rule above laid down has been adhered to.
There has been an allowance for brokerage equal to 5%
on 75% of the cost of reproduction. This amounts to
3.75% on total cost of reproduction. The standard of
fair value used by the commission is market value and
not cost of reproduction, though the latter factor is
doubtless given great weight.
§ 329. Wisconsin Railroad Commission— Rate Cases.
The Wisconsin Railroad Conunission considers the
question of bond discount in the case of Hill v, Antigo
Digitized by VjOOQ IC
§ 329] Discotmr on Bonds 279
Water Company, 3 W. R. C. R. 623, 646, decided Au-
gust 3, 1909. This case involved the determination of
the fair value of a water plant for rate purposes. It was
found that the original bonds issued by the company were
issued at a discoimt of 8% amounting to $5200. In more
recent years there had been additional bond issues and
also additional discounts, such discounts amounting to
$1700. In determining cost of construction the Com-
mission included the $5200 discount on the original bond
issue but excluded the $1700 discount on subsequent
bond issues. The Conmiission did not include the $5200
in the cost of reproduction and what consideration was
actually given it in the fair value for rate purposes is not
clear. The following is from the decision (page 646) :
The last' item in table I is an amount of $5,200 which was
paid as discount on the first issue of the bonds of the plant.
This issue, it appears, amounted to about $65,000, and was
sold at a discoimt of 8 per cent, or at 92 cts. on the dollar.
Whether this is a legitimate cost to be included in the cost of
construction, will perhaps depend upon the circumstances in
each particular case. If the utility is needed and the capital
for it can be had on no better terms, then it is difficult to see
on what ground such discounts should not be included in the
cost of the plant. To so include it has been and is the almost
universal practice. Under such conditions it is simply in the
nature of an extra interest charge, that those who desire the
utility may be willing to pay interest on rather than forego
the service. When the discount is due to the fact that the rate
of interest which the bonds bear is so low that the bonds must,
for this reason, be sold for less than par, then it may also be
a proper charge to the construction account, and this on the
theory that the increase in the cost of the plant from this source
is compensated for by the lower annual interest charges on
the bonds, due, of course, to the low rate of interest which
they bear.
When, on the other hand, discounts on bonds are charged
Digitized by VjOOQ IC
'280 ValxjatioK t§ 32d
to the construction account for, perhaps, no better reason than
that it has been customary to do so, or in order to cover outlays
which it would not be fair to treat as a part of the investment,
then they should obviously be omitted from this account.
Whether bonds will have to be sold at a discount, ordinarily
depends upon the financial condition and prospects of the
company by which they are issued. Companies that are not
overcapitalized, whose earnings are large enough to leave a
fair margin of safety above the interest charges at present
and promise to do so in the future, and whose bonds bear
interest at the ordinary rates, have usually little or no trouble
in disposing of them. In some instances they sell their bonds
above par, in other cases, again, below par, and in still other
instances at par. The variation in prices in such cases usually
depends on monetary conditions and on the rate of interest
which the bonds bear. Under such conditions an equilibrium
might be established by charging the construction account
with all discounts on bonds and crediting it with all premiums
above par. Such methods of dealing with this matter would
seem fair, and there are companies by which it has been adopted.
There are also instances where discounts on bonds are
charged directly to operating expenses. This practice may
also be sound from the company's point of view, especially
when the earnings are large enough to permit it. . If the re-
sults of so charging such discounts should be an increase in
the rates for the services rendered to the public, then this
method would differ from that imder which they are charged
to construction only in this, that in the former case the burden
of paying them falls upon the present generation of customers,
while under the latter method it may largely fall on future
generations or be distributed over both. As to which of these
methods is the better, would seem to be a question that largely
depends upon the life of the plant. Water plants, for instance,
which are largely built for future generations, may be in a
different position in this respect from plants that are of a more
temporary character. The same questions are also involved
in writing oflf costs or losses generally, and should always re-
ceive due consideration.
Digitized by VjOOQ IC
§ 329] Discount on Bonds 281
In the case before us, however, the bonds were sold at a
discount because they could not be sold on any other basis.
The discounts of the first issue were, in turn, charged to the
construction account, because there was practically no other
place where they could have been disposed of. They could
not have been charged to earnings, because these were too
low to permit it. The owners of the plant were probably
neither willing nor prepared to assume this loss; nor was it,
perhaps, their duty at the time to meet this loss out ai their
own pockets. This item was therefore treated in about the
only way in which it could have been treated at the time. It
was included in the cost of the plant, but has probably not
affected the rates, except perhaps theoretically. Furthermore,
under the method of measuring the value of the physical prop-
erty of the plant by the cost of reproduction, items of this
character are probably eliminated from this value, unless some
allowance is made for them in other ways.
In 1899 and 1904 there appear to have been additional bond
issues and also additional discoimts to dispose of. In the case
of issues, however, the discoimts were not charged to construc-
tion, but to operating expenses, thereby reducing the net earn-
ings to that extent. These discounts amoimted to $450 for the
former year and to $1,250 for the latter, or to a total of $1,700.
Of these discounts it must be said that they were borne by the
owners of the plant, and that, if they are not included in the
cost, their ch^^ces of recouping themselves for this loss are
not the best.
In the rate case City of Janesville v. Janesville Water
Co., 7 W. R. C. R. 628, 639, decided August 17, 1911, the
Wisconsin Railroad Commission considers in arriving at
fair value for rate purposes certain discount on bonds
actually incurred in the original floating of the bonds.
The Commission says:
The relation of bond discoimts to plant valuation cannot
be determined without a knowledge of the circumstances ex-
isting at the tune of the bond issue. It has usually been con-
Digitized by VjOOQ iC
282 Valuation [§ 329
sidered that when a community is in need of a utility to supply
a particular class of service and when money for the construc-
tion of the plant can be secured on no better terms, the discount
on bonds constitutes a proper charge to capital. In the present
case there may be some question as to whether money for con-
struction purposes could not have been obtamed on better
terms. A few years later stockholders of the Janesville Water
Company accepted 5 per cent bonds at par. In cases where a
discount on bonds is necessitated by a low interest rate, the
fact that a discount is made amounts to a postponement of a
portion of the interest pa3rment until the date of maturity
of the bonds. In the case under consideration, however, the
interest rate of 6 per cent appears to have been at least as
high as the normal rate for such bonds. The fact that these
bounds were soon afterward reduced to a 5 per cent interest
basis, because the plant was unable to meet a 6 per cent rate,
seems to indicate that some discount was necessary to secure
capital for construction purposes. On the other hand, that
the utility was in poor financial condition may have been due
to the fact that the communuty was not greatly in need of
the water plant at the time it was built, or to the fact that
not enough allowance was made for working capital during
the period in which the business was being built up. Some
allowance, probably, wiU have to be made in fixing the value
of the plant, for the discount on bonds, but it is questionable
whether all of the $19,600 accounted for should be considered
as a plant investment.
In this case the cost-of-reproduction-new amounted to
$243,000 and the cost-of-reproduction-less-depreciation
was $226,700. The fair value for rate purposes was fixed
at $250,000 and it is stated that in fixing such fair value
consideration has been given both to discount on bonds
and to going value.
The City of Marinette v. City Water Co., 8 W. R. C.
R. 334, 342, decided December 14, 1911, is a water rate
case. In this case the Commission further explains and
Digitized by VjOOQ IC
§329] Discount on Bonds 283
limits its position in regard to the inclusion of bond dis-
count in a valuation for rate purposes. The Commission
says:
The president of the water conpamy testified that he was
unable to state the exact amount of the cost of marketing
the first of these issues of bonds, but stated as his belief that
that first $200,000 were sold at about 92}4 pei* cent of their
par value. The $6,872.50 given as the cost of marketing the
last $100,000 of these bonds was stated to be the exact cost.
As indicated in previous decisions of the Commission, the
discoimt or cost of marketing bonds is an element to be con-
sidered in arriving at the value of the property of a utility.
This does not mean that all discounts constitute proper addi-
tions to physical value. If this were the case a company with
poor credit, which had been obliged to allow a large discount
on its bonds, would have a higher value and be entitled to a
return on a greater valuation than a utility owning precisely
similar property, but whose credit was good enough so that
it was not obliged to issue its bonds at a considerable discount.
Similarly, a company would probably find it necessary to
offer a greater discount on 4 per cent bonds than on those
earning 5 per cent, and more on 5 per cent than on 6 per cent
bonds. In the present case the bonds bore 6 per cent inter-
est, which seems to be as high a.rate as was ordinarily pdd on
bonds of similar nature. Owing to the inability of the utility to
furnish definite data concerning these bond issues, it is not
possible to state what effect the condition of the company's
credit had upon the bond discoimts. It may be that some al-
lowance should be made for the cost of marketing these bonds
in arriving at the value upon which rates should be based, al-
though it is questionable whether the total amoimt of discounts
on bonds constitutes a legitimate addition to the physical value
of the plant.
The bonds of 1890 matured on March 1, 1910, and the au-
thorized bonded indebtedness was then increased to $500,000,
of which $381,000 was issued and outstanding at the end of
the fiscal year. The cost to the utility of this new issue appears
Digitized by VjOOQ iC
284 Valuation [§ 330
to have been made up of a discount of $18,400 and a few smaller
and relatively unimportant expenses. Bonds of the new issue
bear interest at 5 per cent, and appear to have been issued
to replace the bond^ of 1890 which were retired. Except pos-
sibly for such part of this outstanding issue as increased the
bonded indebtedness above the former level, there seems to
be no reason for adding to the value of the plant because of
the cost of marketing this new issue of bonds.
The exact amount allowed in this case for bond discount
is not stated.
Among the numerous valuations for rate purposes made
by the Wisconsin Commission the above are apparently
the only cases in which bond discount has been considered.
The rule appears to be that bond discount actually in-
curred will be considered in determining original cost and
actual investment but that it will not be considered in an
estimate of cost of reproduction.
§ 330. ColumbuSi Ohio, Electricity Rate Case, 1906.
Columbus Railway and Light Company v. City of
Columbus is an application for an injunction against the
enforcement of a city ordinance reducing electricity rates.
The Special Master reported in favor of a permanent
injunction and his report was approved by the court with-
out opinion. In considering the actual cost of the plant,
the Special Master says: •
The discount of $22,800 upon certain bonds sold by one of
the constituent companies was a reasonable discount for the
negotiating of bonds of that character at the time they were
sold, and the amount of such discount represents actual cost
to the company.
In the above the special master recognizes discount as a
legitimate part of actual cost. But the fair value found
* Columbus Railway and light Company v. City of Columbus, no. 1206,
in equity, Circuit Court of the United States, Southern District of Ohio.
Eastern Division, Report of Special Master T. P. linn/ June 8* 1906, p. 35.
Digitized by VjOOQ IC
§ 331] Discount on Bonds 285
by the master for the purposes of this case was based
chiefly on cost of reproduction plus intangible elements
and there was apparently no allowance for discount.
§ 331. Lincoln, Neb., Gas Rate Case, 1909.
The case of Lincoln Gas and Electric Light Company v.
aty of Lincohi, 182 Fed. 926, 929, decided April 6, 1909,
is an action to enjoin the enforcement of an ordinance re-
ducing the price of gas from $1.20 to $1.00 per thousand
cubic feet. The application was denied. District Judge
Hunger said:
It appears from the evidence in this case that complainant's
outstanding bonded indebtedness is $1,129,000, and that its
stock is $2,500,000. The stock and bonds are each grossly
in excess of the value of complainant's plant and grossly in
excess of the cost of construction. Complainant's construction
accoimt shows that the entire cost of the plant to June 30, 1907,
was $603,278.14. The evidence shows that complainant and
its predecessor, to obtain money with which to construct the
plant, sold its bonds and stock at an enormous discount, and
I do not think that, in determining the reasonableness of rates,
the amount thereof should be considered.
On appeal to the Supreme Court of the United States
the decree of the lower court was reversed and the case
remanded (223 U. S. 349, February 19, 1912). But Jus-
tice Lurton in delivering the opinion of the court does
not refer to bond discount.
§ 332. Minnesota Railroad Rate CaseSi 1910.
Judge Otis, Special Master in Chancery, in the Min-
nesota rate cases, in his report of September 21, 1910,
takes strong ground against the admission of bond dis-
count in determining the original cost of construction.
Judge Otis sajrs (at page 89) :
There is also included items aggregating $24,709,164 for
discounts made and commissions paid in disposing of its bonds.
Digitized by VjOOQ IC
286 Valuation [§ 333
This, of course, was a necessary and proper expense of the
company, and if required to render an accounting it would be
entitled to take credit therefor, just as it would be allowed in
an accounting demanded with respect to any other business
in which any corporation or private person might be engaged.
It cannot be said, however, that it is money which has actually
gone into the road, but rather an expense which the company
incurs for the purpose of procuring such money. If rate-
making is to be based upon actual cost, it would seem that
such cost must be measured by the money necessarily expended
in producing the construction without regard to whether those
undertaking the enterprise have the same or must borrow for
the purpose — a matter in which the public has no concern.
If allowed interest during construction on the money invested,
more should not be asked; otherwise, the rate would be directly
affected by the good credit or otherwise of those imdertaking
the work.
In approving the report of Judge Otia, CSrcuit Judge
Sanborn did not discuss this question.^
§ 333. Summary— Discount in Rate Cases.
The state commissions, with the partial exceptions
above noted in the case of the Wisconsin and Washington
commissions, have not included brokerage or bond dis-
count in valuations for rate purposes. Moreover, in the
various rate cases that have come before the courts there
is practically no authority for inclusion of bond discqimt.
The decisions for the most part make no reference to the
subject. In such of these as contain details as to the
elements of the valuation it seems clear that no allowance
for this factor has been included. While certain rate
cases indicate that at least some consideration is to be
given to the par value of outstanding securities, it is made
clear that par value may be considered only to the extent
that it may throw light on true value.
' Shepaid v. Northern Pacific Railway Co., 184 Fed. 764, Aprils, 1911.
Digitized by VjOOQ IC
CHAPTER XIV
Working Capital
{a40. General.
34L Capitaluation of working capital.
342. Working capital as estimated for tax purposes in Great Britain.
343. Wisconsin Railroad Commisdon, 1910-1911.
344. New York Consolidated Gas Case.
345. New York Public Service Commission, First District, 1911.
346. Chicago gas plant appraisal, 1911.
347. Iowa Gas and Water Rate Cases.
348. Lincoln, Neb., Gas Rate Case, 1909.
349. Louisville Telephone Rate Case, 1911.
350. New York Special Franchise Tax Case, 1911.
§340. General.
The question of working capital and methods for its
determination have received comparatively little con-
sideration. Writers on the theory of accounts have re-
ferred to it only in the most general terms. It is not a
question that would necessarily arise in connection with
a case of condemnation or purchase. In such cases the
purchaser buys stores and supplies on hand and himself
supplies whatever additional capital is necessary to run
the business. In a rate case or a capitalization case the
problem is different. A plant in operation must have a
working capital as weU as a fixed capital. This working
capital includes stores and supplies on hand and sufficient
funds in addition to bridge the gap between outlay and
reimbursement. A concise statement in regard to the
elements of working capital is contained in a paper by
C. L. Corey, C. E.: ^
> Paper on Rates for gas service, by C. L. Corey, C. £., read before the
Nineteenth meeting of the Pacific Coast Gas Association and printed in
American Gas light Journal, October 23, 1911, p. 260.
[2871
Digitized by VjOOQ IC
288 Valuation [§ 341
Just what sum represents a fair amount for working capi-
tal is nearly always a matter of judgment. From the amount
of working capital usually carried by such companies, and
from the amount that is required by other similar public util-
ity corporations, it appears that, as an average for the year,
a smn equalling the accounts receivable and cash on hand
less tiie accounts payable and consimiers' advance pa3rments,
is a reasonable allowance. The cash on hand, however, should
be considered as that which is ordinarily required for the oper-
ation of the plant and the conduct of the business, including
contingencies and emergencies, and should not include the
capital or ready cash necessary for the construction of exten-
sions or enlargement of the plant, or balances resulting from
the sale of bonds or stock, or in any case exceed the amount
normally needed and used by the company as an operating
property.
In many rate cases no mention is made of working capital
and it does not seem to have been included at all except
as covered by the allowanee for stores and supplies. No
rate case has been found, however, in which there is
recorded a refusal to allow for working capital. The
failure to give more attention to the matter is doubtless
due to its comparatively small influence upon the total
value.
§ 341. Capitalization of working capital.
Under the Massachusetts stock and bond law as it
existed prior to 1909, the State Board of Railroad Com-
missioners refused to allow the issue of stocks or bonds to
cover working capital. The Legislature of 1909 passed
an act authorizing such issue by street railway companies.
This act (Laws of 1909, chapter 485) authorizes a street
railway company, after securing the approval of the
Board of Railroad Conunissioners to issue shares to an
amount not exceeding 5% of the par value of its total
share capital or to issue bonds to an amount approved by
Digitized by VjOOQ IC
§342] WoRKnro Caittal
the Board of Railroad Commissioners ^'for the purpose of
supplying itself with working capital.'' Under the above
act the Boston and Worcester Street Railway Company
was authorissed to issue shares to the par value of $102,000
for working capital.^ The decision of the Board does not
state the basis of the allowance for working capital.
Based on the returns of the company for the year ending
December 30, 1909, the allowance was approximately
5% of the share capital and the share capital amounted
to approximately one-half of the total capitalization
(shares and bonds).
The New York Public Service Commission, Second Dis-
trict, In re Application of the Rochester, Coming, Elmira
Traction Company, 1 P. S. C. 2d D. (N. Y.) 166, 176,
decided March 30, 1908, states that upon an application
for capitalization of a newly organized railroad company
the Commission will make an allowance for a proper
amount of working capital. The Commission says : ' ' The
operation of the company can be conducted with far
greater efficiency, more to the satisfaction of the public
Mid with better results to the stockholders if it has at all
times in its treasury a working capital sufficient and ad-
equate to meet the requir^nents of the road."
{848. Workiiig capital as estitiuited for tu purposes in Great
Britain.
Under the tax laws of Great Britain, taxes are assessed
on the rental value of real i»-operty. As gas and water
undertakings are not usually held on a tenancy, the rental
value has to be found by assuming a hjrpothetical tenant
and inferring the rent from the available evidence. This
involves among other things an estimate of the structural
* Pedtkm of tke Borton and Worcester Street Railway Compaxiy, de-
cked Febnuffy 18, 1910. 43d' AnQual Report of the Railroad Commia-
aooenfp. 102.
19
Digitized by VjOOQ IC
290 Valuation K343
value of the works and also an estimate of the tenant's
capital necessary for the conduct of the business. The
amount of working capital required is based on operating
expenses during the estimated period elapsing before
current receipts will meet current expenditures, less the
estimated amount of receipts during such period. In
England, gas bills are rendered quarterly and it is esti*
maled that it is some six weeks or two months after the
end of the quarter before money received from day to day
is sufficient to meet expenditures. Capital must there-
fore be provided to meet the excess of expenditure over
receipts for a period of four and one-half or five months.
But although ordinary gas bills are rendered quarterly,
there are considerable sirnis received during the quarter
from prepayment meters, sale of residuals and bills ren-
dered at shorter intervals as is the case when a consmner
moves from one house to another. An amoimt is added
for the estimated amount of taxes that may be required
to be paid during this period. No allowance is, howevOT,
made for a payment of interest or dividends. In addition
there is a small allowance added to cover minimum cash
balance in bank. The assumption upon which the ten-
ant's capital is based is that the whole of it will be re-
quired at one time even though that time be short. Con-
sequently, it is deemed necessary to provide a minimum
cash balance as this is often a requirement made by the
bank as a condition of keeping the account. To the above
is also added the stock of coal, residuals, and stores on
hand.'
§ 343. Wisconsin Raikoad Commission, 1910-1911.
The case of State Journal Printing Co. t;. Madison Gas
' Rating of gas and water undertakings, by Arthur Valon, published in
the Journal of Gas Lighting, London, February 21, 28, March 7, 14 and
28, 1911. See particularly p. 517, February 21st and p. 669, March 7th.
Digitized by VjOOQ IC
§343] Working Capital 291
and Electric Co., 4 W. R. C. R. 501, 561, decided March 8,
1910, involves the valuation of a gas and electric plant for
rate purposes. In its opinion in this case the Wisconsin
Railroad Commission discusses the allowance for working
capital in part as follows:
That stocks and supplies and cash in sufficient amounts
to insure economical and safe operation of th^ plant are proper
items to be included in the working capital, is clear. This,
in a sense, might also be true of bills receivable, except in
such cases where they are offset by bills payable. The mech-
anism and nature of modem industry are such that the bills
can not be collected on the delivery of the goods, and hence
thirty and even sixty days' time for payment of bills are
usually regarded as cash sales. The effect of this is, that bills
and accoimts receivable, and bills and accounts payable, to
a considerable extent tend to offset each other, and that the
former, for this reason, may not be an essential part of the
working capital. Gas in the holder and gas and current de-
livered but not billed would, in this case, seem to be items
that belong with earnings and operating expenses rather than
in the capital account. For a company so situated as the one
in question here, the essential items in working capital would
seem to consist of stores and supplies and cash on hand. . . .
The company obtains its revenues from the gas and the elec-
tric current it manufactures and sells. It collects those rev-
enues from its customers very promptly about the 10th of each
month. Its outlays consist of the cost of producing, delivering
and selling this gas and electric current, or of the cost of fuel,
material for repairs and renewals, certain other supplies of vari-
ous kinds, the wages of the labor it employs in the operation,
repairs and renewals of its plant, the salaries of its clerks and
officers, taxes, interest and profits on the investment. Coal
is the principal material that is used in the production of gas
and electric current, and is also in most cases the largest single
item of expense. Inquiries upon this point indicate that,
when storage and handling are taken into consideration, coal
can be contracted for in larger quantities and paid for about
Digitized by VjOOQ IC
292 Valuation (§ 343
as delivered, or monthly, on terms that are about as favorable
as any that can be had. In fact, such transactions are usually
regarded in about the same light as ordinary cash deals. Other
supplies can probably be bought on thirty days on practically
a cash basis. Wages and salaries are ordinarily paid monthly
and about the time the bills for the gas and current sold are
collected, or can be so paid. Taxes, interest and profits are
not likely to be paid oftener than in one or two annual install-
ments. The receipts, taken as a whole, are about one-third
greater than that part of the expenses which, when considered
together, it would be of any advantage to the plants to pay
as often as once a month.
These facts are significant. They show that the company
is in a position where it is practicable for it to meet at least
the greater proportion of its current outlays from its ciu-rent
receipts, or to meet these outlays on a basis that is practically
the equivalent of cash transactions. They make it clear that
the conditions under which the business of this company is
or can be done, are such that there is a very close relation be-
tween the collection of its receipts and the pa3nnent of its ex-
penses, so close, in fact, that there ought to be little or no trouble
in a reasonably uniform adjustment of the one to the other.
There are, of course, certain items of the expenses, such as
renewals and repairs, particularly in case of accidents, that
may be much heavier at some periods than at others and which
can, therefore, be more economically met when there are ample
funds on hand. It is also a fact that, with a liberal amount
of quick assets available, new extensions to the plants may be
more cheaply constructed than otherwise, and this for the
reason that temporarily it may be more economical to use
working capital for such purposes than to meet the cost by
regular loans or by the sales of new securities. There may
also be other circumstances under which it is profitable to
the plant to be fortified by an ample working capital. But,
upon considering the facts thus presented, one can not help
but feel that the respondent claimed a greater amount for
this purpose than that which is required for operating the
plants and conducting their business as a whole, with a rear
Digitized by VjOOQ IC
5 343] Working Capital 203
sonable degree of economy, effectiveness and safety. In fact,
it appears to us that a working capital of even less than 15
per cent, of the amount derived from the sales of gas and cur«
rent or of from $45,000 to $50,000, is fully adequate under
present conditions.
In the above case the total working capital allowed was
$49,674, of which amount $30,130 consisted of stores and
supplies. This amoimt covered working capital for both
the gas and the electric lighting business. The allowance
for the gas business alone was $23,855, of which $14,924
was for stores and supplies and the balance, $8,931, for
addition'&l working capital. The amount of gas sold
amounted in 1908 to 116,354,000 cubic feet. This allow-
ance amounted, therefore, to about 20 cents per thousand
cubic feet of gas sold. The Commission fixed a rate for
gas varying from 90 cents net to $1.15 net. The case of
City of Beloit v. Beloit Water, Gas and Electric Company,
7 W. R. C. R. 187, 242, 378, decided July 19, 1911, is also
a rate case. The Conunission allowed a total of about
$40,000 for working capital, including stores and supplies
on hand amounting to $25,250. The opinion does not
state on what basis this allowance is made but includes a
statement showing current assets and current liabilities
and then states that: ''The revenues from the gas and
electric consumers are collected monthly, being payable
on or before the tenth of the month following the month
for which the bill is rendered. The water rates, under
the fiat rate system in use in Beloit, are payable quarterly
and in advance, a penalty being added in case of pay-
ments which are not promptly made."
In re Application of La Crosse Gafi and Electric Com-
pany for authority to increase its rates, 8 W. R. C. R. 138,
187, decided November 17, 1911, the Commission allows
$35,000 for working ca^Mtal, which amount includes stores
and supplies on hand valued at $13,947. In this case the
Digitized by VjOOQ IC
294 Valuatiok [§344
gross earnings of the combined gas and electric plants
amounted to $323,000 so that the Commission's allowance
for working capital is a little over 10% of the gross earn-
ings. In its opinion the Conmiission tabulates current
assets and current liabilities for various periods and ob-
tains the difference between the assets and the liabilities,
but what consideration, if any, is given to this factor, is
not stated.
§ 344. New York Consolidated Gas Case.
In the New York City Eighty Cent Gas Case, the
Special Master made an allowance of $3,616,000 for work-
ing capital. This allowance was reduced by District
Judge Hough to $1,616,000. The Special Master in his
report says (at page 179) : *
This is found in the shape of current supplies, cash and bills
and accounts receivable. According to Mr. Carter, com-
plainant's material and supplies, consisting of coal, coke, oil,
lime, etc., aggregated $616,470.08, as of October 31, 1905.
In addition to this he testifies that $1,000,000 in cash was a
fair conservative amount of working capital for the cur-
rent purposes of a Company like complainant, besides its
accomits receivable outstanding to the extent of $2,000,000.
His total estimate, therefore, aggregates $3,616,000. Dr.
Humphreys testified that a fair allowance for working capital,
including cash, accounts receivable and material, would be
about 30 cents per thousand cubic feet of annual sales. On the
basis of annuaJ sales amounting to 13,283,000,000 feet (the
complainant's sales for 1905), this would represent a work-
ing capital of $3,984,900. . . .
Although the necessity for working capital is conceded by
the witnesses for the City, the subject is not discussed at
* See Conaolidated Gas Company v. Mayer, Report of Arthur H. Masten,
Master in Chancery, United States Circuit Court, Southern District o^
New Yoric, May 18, 1907, as printed in United States Supreme Court
Complete Record, Volume 1, pp. 151-205, in case of Willcox v. Conaolidated
Gas Company.
Digitized by VjOOQ IC
§344J Working Capital 296
length in counsel's brief excepting that in summarizing the
cost of property devoted to the gas business, there is included
$1,303,000, being the same amount set aside for working
capital at the time of the consolidation in 1884. No testi-
mony on the subject was offered by the State authorities and
counsel in their brief include no allowance for working capital
in their statement of the maximum amount which they claim
as the value of complainant's property devoted to the public
use on December 31, 1905. As the sales of gas for 1885 were
approximately 4,000,000,000 feet as against approximately
13,000,000,000 feet for 1905, it is manifest that a much larger
working capital is now required than that conceded by the
City, and nothing is foimd in the evidence to justify the con-
clusion that the sum of 13,616,000, claimed by complainant,
is excessive.
District Judge Hough in reviewing the Master's report
says: *
Upon this subject I am unable to agree with the report,
further than to express my belief that the complainant usually
has on hand about 13,000,000 worth of bills receivable and
cash, and some $616,000 worth of bills payable outstanding.
But it does not follow that so large a proportion of its capital
account should be entered as working capital. That phrase
means the amount of cash necessary for the safe and conven-
ient transaction of a business, ha\dng regard to the owner's
ordinary outstandings, both payable and receivable; the ordi-
nary condition of his stock, or supplies in hand; the natural
risk of his business, and the condition of his credit; and unless
these matters, and perhaps others, be looked into, no com-
parison can be drawn between one business and another, or
even between those of the same general nature. The security
of complainant's business is fairly shown by the fact that for
the time of inquiry, in a gross business of over $13,000,000,
bad and doubtful debts amoimted to less than $83,000, and
final profit and loss adjustment less than $30,000.
•Consolidated Gas Company v. Qty of New York, 157 Fed. 849, 859,
December 20, 1907.
Digitized by VjOOQ IC
296 Valuation [§ 345
Complainant's credit is of the higheet, and its own comp-
troller should, I think, be the best judge of its own necessities;
and his measure of working capital in the sense of cash is
$1,000,000. Six hundred and sixteen thousand dollars is
taken as a fair average of outstanding bills payable, and the
aggregate of these two sums is as much as the comptroller
claimed, until, on suggestion, he added $2,000,000 thereto, to
represent the average amount of outstanding bills receivable.
To assert that a concern with such credit as ccHn^dainant,
with small percentage of loss, and a plant completed and paid
for, needs as working capital not only the amount of its average
outstandings payable and $1,000,000 in cash, but enough more
to make its average bills receivable equal to cash, is going too
far. A fair working capital for oomplaiaant is $1,616,000, and
that figure is adopted.
The allowance made by the District Court consistd of
approximately $616,000 for supplies on hand and an ad-
ditional allowanoe of $1,000,000, making a total working
capital of $1,616,000. Judge Hough refers to the $616,000
as an allowance for ''bills payable outstanding" but this
as indicated by the report of the master is not the amount
of bills payable at all but the value of material and sup-
plies on hand. The annual sales of gas in 1905 amounted
to 13,283,000,000 feet. The total allowance for working
capital was therefore equal to 12.17 cents per one thousand
feet of gas sold. The case then went to the United States
Supreme Court on appeal. Justice Peckham, however,
in stating the conclusions of the court, makes no mention
of working capital.'
§ 346. New York Public Service Commission, first District,
1911.
A particularly discriminating discussion of working
capital is contained in Commissioner Maltbie's opinioa
• Willcox V, Cooaolidftted Gaa Cknopany, 212 U. S. 10, 29 Sup. Ct. 192,
53 L. ed. 382, January 4, 1909.
Digitized by VjOOQ IC
§ 345] Working Capital 297
in the case of Mayhew v. Kings County Lighting Cc»n-
pany, 2 P. S. C. 1st D. (N. Y.) — , «Iecided October 20,
1911. He says:
A gas company must purchase materials and supplies, must
pay its employees and must distribute its commodity to con-
sumers in advance of payment for such service. This requires
a fund ordinarily called working capital. It is reimbursed
from operating receipts from time to time, but originally is
provided from capital. The amount needed depends upon
the advances that must be made and the period for which they
must be carried. . . .
The relation of current assets to current liabilities is not
a fair index of the amount of working capital needed, for some
companies prefer to finance their daily operations through
temporary loans; others issue securities to provide the neces-
sary funds. Working capital does not vary with each change
in financial methods, but depends for its justification, so far
as rate cases are concerned, upon entirely different grounds.
Furthermore, current assets and liabilities vary greatly from
month to month. If meters are read just before the end of
the month, as is the practice of this company, the monthly
statement will show a large entry under consumers' accounts
receivable. If a date is chosen just before dividends are de-
clared, the cash balance will be large; yet it has no relation
to working capital, for it has largely been accumulated out
of earnings and not from capital. Cash obtained from the
sale of securities for construction purposes has no relation
to working capital, but it is a current asset. Likewise a surplus
represented by current assets would not be germane, for it is
derived from operating income and not from capital.
It has been argued that provision should be made in work-
ing capital for new construction, extensions and additions, but
this argument does not seem to be well founded. It will be
recalled that allowance has been made for interest upon cost
during construction, and that it has been computed not merely
upon the original initial plant, but upon every extension and
addition made to date, and likewise would be computed upon
Digitized by VjOOQ IC
298 Valuation [§ 346
all future extensions and additions. In view of. this fact, and
that the cost of these bettennents is also included, it would
clearly be a duplication of property to make an allowance for
the same items in working capital. However, it does seem
proper to provide for materials and supplies to meet repairs
and renewals promptly.
Taking into account all conaderations that are proper, it
is the opinion of the Commission that an allowance of $80,000
for working capital for the year 1910 would be ample.
This allowance of $80,000 includes $39,643 for mate-
rials and supplies on hand. In 1910 the company sold
580,678,000 cubic feet of gas. Therefore the allowance
for working capital amounted to 13.77 cents per thousand
cubic feet of gas sold.
§ 346. Chicago gas plant appraisali 1911.
In appraising the property of the People's Gas Light and
Coke Company of Chicago for rate purposes, William J.
Hagenah, in his report of April 17, 1911, to the City
Council Committee, allows $3,200,000 for working capital.
In this case the total value of the physical property was
$49,023,947 and the gross operating revenues, $14,302,447.
Mr. Hagenah says (at page 42) :
The best information as to what constitutes a reasonable
allowance for working capital is supplied by the balance sheets
showing the current assets and the current liabilities. . . .
There is no fixed rule by which the amount of working
capital can be computed. The range of maximum and minimmn
allowance can be ascertained with reasonable accuracy, but
there are numerous demands on the company which are not re-
flected in the balance sheet, but must be arrived at through
the application of a reasonable judgment. Among such items
mention may be made of cash requirements to guard against
contingencies, the allowance for temporary financing of plant
extensions, the cost of gas which has been consumed by the
customer since the last reading of his meter and also the cost
Digitized by VjOOQ IC
§ 346] WoBKiNG Capital 299
of gas in the holders and distribution system. A review of all
the balance sheet items and other factors materially affecting
working capital must lead to the conclusions that an allowance
for 1909 of $3,200,000 is approximately correct. This amount
is therefore used in the computation of the investment value
ui^n which the stockholders are entitled to a reasonable return.
After the above report was submitted, the complexion of
the council committee changed and the new conmiittee
asked Edward W. Bemis to present a report reviewing
the findings contained in the Hagenah report. In regard
to working capital, Mr. Bemis says: ^
Mr. Hagenah, in a discussion of working capital, pages 40-43,
allows $3,200,000 for 1909. The United States Supreme Court,
in the Consolidated Gas Case of New York, indorses the de-
cision of Judge Hough in the United States Circuit Court,
which allows for that Company $1,616,000, or 12.17 cents per
1,000 feet of sales m 1905, of 13,283,000,000 feet. Applying
this figure to the estimated sales of 17,148,322,000 feet, of
the Peoples Gas Light & Coke Company in 1910, would yield
a working capital of $2,086,951, or say $2,100,000.
In reaching his conclusions. Judge Hough held that it was
not necessary to capitalize the accounts receivable, while the
accounts payable, which he did capitalize, were sufficient for
supplies and stores on hand. Yet a considerable portion of
these accounts payable probably bore no interest.
The Peoples Gas Light & Coke Company increased its cash
on hand from $1,322,664 at the close of 1906 to $4,819,934 at
the close of 1910, but nearly all of this increase appears to have
been accmnulated for the new office building and other con-
struction purposes. There appears to be no good reason for
allowing for actual working capital for operating purposes in
Chicago more than the $2,100,000 obtained by following the
precedent of the New York Consolidation Gas decision.
' Rqx)rt upon the price of gas in Chicago for the Chicago Council Com-
mittee on gas, oil and electric light by Edward W. Bemis, July 1, 1011,
p. n.
Digitized by VjOOQ IC
300 Valuation [§ 347
§ 347. Iowa Gts and Water Rate Cases.
The case of Cedar Rapids Gas light Company v. Cedar
Rapids, 120 N. W. 966, 969, decided May 4, 1909, Su-
preme Court of Iowa, involves the valuation of a gas plant
for rate purposes. In regard to working capital the court
says:
The witnesses for the company estimated that $25,000 would
be required as working capital, aside from the suppUes ordi-
narily carried, which included 1,000 tons of coal and 10,000
gallons of oil, but were unable to sustain their opinion save by
dealing in probabilities for its use, in the main speculative.
It appears that collections for gas sold are made monthly, and,
as these amount to about 18,000 per month, it is evident that,
after the first month, enough would be on hand to meet ciurent
expenses. As supplies on hand were sufficient for immediate
use, and for some months in the future, about all essential
would be enough to take care of the pay roll for the first month,
and $2,500 would be ample for that purpose and other x>ossible
contingencies. Even this much appears to be more than the
company in its experience has foimd it necessary to reserve.
The opinion does not include the estimated value of
materials and supplies on hand, which information is
necessary in order to determine the total allowance of the
court for working capital. In 1907, the company sold
103,079,190 cubic feet of gas. The decision in this case
was affirmed by the Supreme Court of the United States
in Cedar Rapids Gaslight Company v. Cedar Rapids,
223 U. S. 655, decided March 11, 1912. Justice Hohnes
states that the attitude of the state court was "fair."
There is no direct reference, however, to the subject of
working capital.
The case of Des Moines Water Company v. City of Des
Moines, involves the valuation of a water plant for rate
purposes.^ In this case no mention or allowance is made
* Des Moines Water Company t;. City of Des Moines, no. 2468, in equity.
Digitized by VjOOQ IC
§ 348] Working Capital 301
for working capital either in the report of the master or m
the opinion of Judge Smith McPherson confirming the
master's report. The physical valuation, however, in-
cludes an item of between $28,000 and $33,000 for stock,
tools and supplies.
§ 348. Lincoln^ Neb., Gas Rate Case, 1909.
The case of Lincoln Gas and Electric Light Company
V. City of Lincohi, 182 Fed. 926, 928, decided April 6,
1909, is an action to enjoin the enforcement of an or-
dinance reducing the price of gas from $1.20 to $1.00 per
thousand cubic feet. The application was denied. In
regard to working capital District Judge W. H. Mimger
says (at page 928) :
But it is apparent that, for the successful and economical
operation of the plant, a certain amount of working capital
is required. This amount I find to be $50,000, making the total
value of complainant's investment, upon which it is entitled
to a reasonable return, $566,073.59.
While it is true the testimony shows that the complainant
has not such working capital but has purchased upon credit
the supplies necessary to operate, yet I think that, in determin-
ing what is a reasonable compensation, a working capital should
be considered.
This decision was reversed and the case remanded by the
Supreme Court of the United States in Lincoln Gas and
Electric Light Company v. City of Lincoln, 223 U. S. 349,
decided March 11, 1912. Justice Lurton in delivering the
opinion of the court does not, however, refer to the ques-
tion of allowance for working capital.
§ 349. Louisville Telephone Rate Case, 1911.
The case of Cumberland Telephone and Telegraph
Report of Geoi^ge F. Henry, master in chancery to the Circuit Court of the
United States, South^n IHstoict of Iowa, Central Division, filed September
16, 1010.
Digitized by VjOOQ IC
302 Valuation [§360
Company v. City of Louisville, 187 Fed. 637, 646, 648,
decided April 25, 1911, is a suit to enjoin the enforcement
of a rate ordinance. In a decision granting the desired
injunction District Judge Evans says:
(4) It seems to us that a proper amount of working capital
should have been included in any estimate of the present value of
the plant. In normal cases (and we may assume this to be such)
it would play a very important part in enterprises like a tele-
phone company. No association of prudent business men
probably would attempt to conduct a large business, such as
that involved in this case, without keeping a considerable
working capital on hand devoted to that business and which
would really be embarked in it. It would seem to be quite
essential to the successful operation of any great plant that
some working capital should be kept on hand and available
for immediate uses, and such capital would seem to be a very
proper and important part of the property which, it may fairly
be said, is " being used for the public." It may be difficult, how-
ever, to say in this case, as in all others, precisely what the
amount of such working capital should be.
Very similar considerations apply to what are called "supplies
on hand." We think prudent management demands that a
reasonable quantity of articles certain to be called for in the
operation of the plant should be kept on hand, and, if on hand,
should be included in any estimate of the present value of the
property which is "being used for the public." ... In their
exclusion from the estimate we think the Special Master pro-
ceeded upon an erroneous theory, and we have concluded that
their valuation should have been fixed as follows: The work-
ing capital at S33,000 and the supplies on hand at $18,000 — ^a
total of $51,000. We incline to think that the term "work-
ing capital" might embrace both items, as supplies on hand may
fairly be regarded as part of the working capital in another
form.
§ 360. New York Special Franchise Tax Casei 1911.
People ex rel. Manhattan Railway Company v. Wood-
Digitized by VjOOQ iC
§ 350J WoBKiNG Capital 303
bury, 203 N. Y. 231, 96 N. E. 420, decided October 17,
1911, is a special franchise tax case. The value of the
special franchise was detennined by the net earnings rule
which provides for the capitalization of the surplus net
earnings after allowing a 6% return on the value of the
tangible property. The com* included with the tangible
property an allowance for working capital. Judge Gray
in delivering the opinion of the coiui) says (at page 234) :
I think, also, that there should have been included in the
tangible property the sum of $537,139, consisting in cash and
other CBsh items on hand. This item may, properly, be con-
sidered as a part of the relator's working capital, which it was
entitled, in the prudent management of its business, to keep
on hand. Whether or not it was, in fact, essential to the opera-
tion of the railroad is not material; but it was, nevertheless,
an item of its property, which it may fairly claim to have con-
sidered with the rest of its tangible property, upon which the
return should be estimated.
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CHAPTER XV
Piecemeal Construction
{ 360. Treatment of ^eoemeal oonfltniction by WlBoonsin Railroad Com-
mission.
361. Oklahoma Supreme Court denies allowance for piecemeal oonstnio-
tion.
362. Discussion of piecemeal construction.
§360. Treatment of piecemeal construction by Wisconsin
Railroad Commission.
The effect of piecemeal construction upon the cost of a
plant is discussed by the Wisconsin Railroad Commission
in Hill V. Antigo Water Company, 3 W. R. C. R. 623,
634, decided August 3, 1909:
This piecemeal construction, like all retail business gener-
ally, is supposed to be relatively more costly than if the en-
tire plant had been built in one continuous operation. In fact,
many engineers in testifying for the utilities have placed the
additional cost through piecemeal construction at as high a
figure as 10 to 25 per cent, of the total cost of the plant.
But the Conmiission states that there are some savings in
piecemeal construction:
New extensions, for instance, are often entirely planned and
supervised by the operating force of the plant which is already
organized and which is merely performing these duties in addi-
tion to their other duties and without, perhaps, adding much
of an3iihing to the total expense. In this way the cost of en-
gineering, supervision and management may become even rela-
tively less for extensions than for the original part of the
plant. . . . For these and other reasons it is by no means
certain that the extensions are always any more costly, rela-
tively, than the oripnal part of the plant, or that plants which
[304J
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PiECEMEAii Construction 305
have been enlarged or extended from time to tame are always
relatively more costly than if they had been built as one con-
tinuous operation. . . . That the increase in the cost, however,
becatise of piecemeal construction is often as great as to amount
to 15 per cent, of the total cost of the plant, appears to us rather
doubtftd.
In State Journal Printing Co. i;. Madison Gas and
Electric Company, 4 W. R. C. R. 501, 546-49, decided
March 8, 1910, the Conmiission discusses at length the
question of piecemeal construction:
Among the elements of additioaid cost of piecemeal over con-
tinuous construction were mentikmed the advantage that could
be gained in buying materials in large quantities for continuous
construction over small purchases as in piecemeal construction,
tiie economy of laborers' time in continuous construction over
piecemeal ccmstruction, in which latter case much time would
be lost in traveling from one small construction job to another,
the large expense of maintaining continw>us operation of the
plant during piecemeal construction as contrasted with con-
tinous construction, also an element of value arising from
the fact that one might be willing to pay more for a {dant that
was completed and ready for operation and not have to take
the risk of additional eacpense arising out of contingencies,
this value being the premium for insurance on the business
capacity and ability of the engineers and others connected with
the project. The extent of this additional cost of piecemeal
coii6truoticm was estimatad by one witness as being in ^some
cases 100 per cent, over what continuous construction would
cost, but, as stated; it was the opinion of three of the respond-
ent's witnesses that an allowance of 15 per cent, would be suffi-
cient on this account. . . .
The engineer of the Commission stated at the hearing, and
in his revised statement of valuation, that the inventory valua-
tion was sufficiently high to cover this alleged extra cost by
reason of pieeemeal construction. In making tiie valuation
each item had been taken separately, as though purchased in
20
Digitized by VjOOQ IC
306 Valuation t§ 361
open market, and no consideration was had of the fact that
the company or contractor would secure special figures in pur-
chasing larger quantities of the material, equipment and labor.
Actual conditions of construction had been liberally represented.
The above case involved the valuation of a gas and elec-
tric plant for rate purposes.
In another rate case, City of Ripon v. Ripon Light and
Water Company, 5 W. R. C. R. 1, 15, decided March 28,
1910, the Commission says:
In making the valuation of respondent's property the Com-
mission's staff has taken cognizance of the subject of piece-
meal construction. The allowance of additional value for piece-
meal construction, as requested by respondent, as a rule goes
only to the outside plant, since the station with its equipment
is constructed as a unit. The valuation of the distribution
system and other outside property has been made with regard
to separate construction rather than a continuous building pro-
gram. With the application of average prices, irregularities are
eliminated and the valuation determined without regard, in
so far as possible, to those forces which, after all, are as apt to
operate in favor of one party as another.
The question of piecemeal construction is further dis-
cussed in City of Beloit v. Beloit Water, Gas and Electric
Co., 7 W. R. C. R. 187, 240, decided July 19, 1911.
§ 361. Oklahoma Supreme Court denies allowance for piece-
meal construction.
An aUowance for piecemeal construction was denied in
Pioneer Telephone and Telegraph Co. v. Westenhaver.^
In this proceeding the Oklahomia Supreme Court reversed
an order of the Oklahoma Corporation Commission re-
ducing the rates of the complainant in City of Enid, Okl.
^ Pioneer Telephone and Telegraph Company t;. Westeohaver, 29 OkL
— •, 118 Pac. 354, January 10, 1911,
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§361] Piecemeal Construction 307
The company ajsked for an allowance of $6,000 on a
total cost to reproduce of $94,000, to cover piecemeal con-
struction. The Supreme Court, however, refused to
allow this item, holding that it formed no part of cost-of-
reproduction-new (at page 357):
The evidence upon which appellant insists item No. 2, re-
fused by the Commission, should have been allowed is sub-
stantially as follows, quoting from one of its witnesses: "The
necessity of concentrating the large number of wires required
of the larger city of Enid makes it advisable to adopt a different
distribution or arrangement of pole lines. This involved the
moving of some of the old poles in the lines, in order to shorten
up spans to get sufficient strength for carrying the larger cables.
The moving of the poles is an expensive undertaking, as same
must be moved without crossing up or interfering with the
vnres then being used in the old plant. In a great many in-
stances new leads crossed old leads in such a way that extra
work had to be done to prevent the new work from interfering
with the operation of the old plant. The subscribers' instru-
ments had to be rewired and adapted to work temporarily on
the new plant until final changes should be made. In fact,
there was no part of the new work that did not have to be
worked out with some special regard to the protection of the
old plant in order that service might be continued.'' Wie think,
however, the Commission committed no error in refusing to
allow this item. The fact that appellant's plant has been
constructed piecemeal does not increase its present value, al-
though the cost of construction by such method may have
been greater than if it had been constructed at one time. The
plant, in our opinion, in arriving at its cost of reproduction
new, should not be considered as an existing obstruction upon
the streets which would have to be worked around in con-
structing a new plant of a similar kind. The fact that other
obstructions, such as telegraph systems or other telephone
plants, exist in the streets at the present time, and would have
to be worked around at this time in building a plant like ap-
pellant's, might require an allowance in arriving at the cost
Digitized by VjOOQ IC
906 Valuation [§ 362
of repnxluciion new of appellant's plant; but a determination
of that question is not required here, for it is not for such ob-
struction that this item is claimed.
§ 362. Discussion of piecemeal construction.
From the above it will be seen that there may be a close
relation between piecemeal construction and inadequacy.
Of course in one sense it is perfectly true that there will be
no additions or extensions unless the old plant is in some
measure inadequate to meet the legitinoate demands upon
it. But properly speaking, a given structure or appliance
becomes inadequate when through growth of the business
it must be replaced by a larger or stronger structure or
appliance. Inadequacy of this kind is undoubtedly a
proper charge to operation. Undw approved systems of
accounting it would not be charged to capital. The re-
construction of pole lines (mentioned above) in order to
seciue sufficient strength for the carrying of larger cables
is clearly a case of inadequacy rather than an illustration
of increased construction cost due to piecemeal construc-
tion. Increased cost due to the necessity of working
around the old structures and of keeping up the service
dimng the progress of the work, seems to lie on the
borderland between piecemeal ccHistruction and inade-
quacy. But decreased per unit cost of large jobs over
small jobs due to the undoubted advantages of lai|^ scale
production and construction is clearly the more usual
basis of the demand for an allowance for piecemeal con-
struction. Public utility plants are continuously in need
of additions and extensions. The result is that the exist-
ing plant has been constructed piecemeal.
Piecemeal construction is therefore an undoubted factor
in estjnaating the actual cost of an existing plant. Whether
it will also be considered in estimating cost of reproduction
will depend on the interpretation of that term. If by
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§362] Piecemeal Construction 309
cost of reproduction is meant the cost under present con-
ditions of reproducing the plant complete there will be no
place for an allowance for piecemeal construction as the
plant will be reproduced as a whole and not by the piece-
meal process. However, a more generally equitable inter-
pretation of cost of reproduction assxunes a construction
at present prices of labor and materialfl but under sub-
stantially the same conditions as existed at the time of
original construction. Under this interpretation of cost
of reproduction the extra expense of piecemeal construc-
tion should receive proper consideration. While it is
doubtless usually considered, it is not usually made a
separate element in the valuation but is allowed for in
the determination of the unit {urices as indicated in the
opinions of the Wisconsin Railroad Commission above
cited (§ 360). That is, the unit prices used are not the
lowest wholesale prices but such prices as would probably
prevail for a plant constructed piecraieal.
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CHAPTER XVI
Adaptation and Solidification
{ 370. Definition — Minnesota railroad appraisal, 1908.
371. Washington railroad appraisal, 1908, and subsequent rate valua-
tions.
372. Texas, Michigan and Wisconsin railroad appraisals.
373. South Dakota raihroad appraisal, 1910.
374. Appraisal of N. Y., N. H. & H. R. R., 1911.
375. Texas Railroad Rate Cases, 1892-1898.
376. Oklahoma Railroad Rate Case, 1910 — Physical and oommerdal
adaptation.
377. Minnesota Railroad Rate Case, 1911.
378. New York Raihx>ad Tax Case, 1911— Seasoning disallowed.
379. Irrigation Rate Case, 1911 — Claim for solidification of earthwork
rejected.
380. Adaptation of street railway — New Yoik Public Service Commis-
sion, First District, 1912.
381. Alabama Railroad Rate Cases, 1912.
382. Summary.
§ 370. Definition— Minnesota railroad appraisal, 1908.
In December, 1908, the Minnesota Railroad and Ware-
house Commission completed a valuation of the railroads
of the State.* The appraisal was intended for use in rate
matters and was made under the direction of Dwi^t C.
Morgan, engineer. Like the other general state raibx)ad
appraisals it is an estimate of cost of reproduction and of
existing depreciation. Mr. Morgan allowed an item of
$11,743,007 to cover the cost of adaptation and solidifica-
tion of roadbed. This is about 20% of the estimated
reproduction cost of the grading. He defines these terms
as follows: "Adaptation in its application to the problem
of reproduction cost is the adjustment of the physical
^ See Amiual Report Mmnesota Railroad and Warehouae Commission,
1906, p. 40.
[3101
Digitized by VjOOQ IC
§3711 Adaptation and Solidification 311
line to its environments and purposes. Solidification of
roadbed is its settlement to a stable condition. The terms
are closely related to each other, yet neither in itself gives
adequate expression to, or clearly defines, the meaning
and scope of the application." Mr. Morgan states that
a railroad is seldom if ever completed at the time that
actual operation' is imdertaken. ''The newly made ex-
cavations wash and slip, the ditches fill from the action
of the elements, the embankments settle and the track
superstructure is in almost constant need of attention;
resurfacing, lining and dressing of ballasted and unbal-
lasted track is necessary, waterways become clogged up,
bridges settle or go out of line, station grounds are to be
improved and finished, scattered and unused material
must be picked up and stored, in fact, all the loose ends
which JBire the immediate sequence of construction must
be gathered in and the property brought to an orderly
condition." The Minnesota Railroad and Warehouse
Conamission to which Mr. Morgan's report was submitted,
refused to allow the inclusion of the item to cover adapta-
tion and solidification of roadbed, on the theory that this
item of cost was paid for from operating expenses and
was not a proper item in the reproduction cost of con-
structed lines.
§ 371. Washington railroad appraisal, 1908, and subsequent
rate valuations.
In the Washington Railroad appraisal, 1908, the Com-
mission made an allowance for '^ seasoning" of roadbed
similar to that covered in the Minnesota appraisal under
the term '^ adaptation and solidification of roadbed." In
valuing the Great Northern Railway Company, the Com-
mission stated that an allowance of 10% on the cost of
grading and surfacing should be made for seasoning. The
following is from the findings of the Commission: ^'That
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Sl2 ValuawoK I§ 372
after a railroad is originally confitructed and after the
same is turned over to the operating department, im-
provements are constantly made in the grading and sur-
facing of the road by section men and by the operating
department of the road, the expenditures of which are
necessarily charged to the cost of operation and that for
approximately five years after such road is turned over
to the operating department, the grade undergoes what is
known as seasoning, and after said term of five years said
grade has appreciated in value and is approximatriy of a
value 10 per cent, greater than its value would be at the
time the same was turned over to the operating depart*
ment. This seasoned value has, however, been CQn*»
sidered and allowed in the imit quantities hereinb^ore
given and in the cost of reproduction hereinbefore set
out." ^ In valuing an int^xu^xtn electric railway the
Washington Conunission in a later decision also allowed
10% for seasoning of roadbed. (See Paulhamus v. Puget
Soimd Electric Railway, February 26, 1910, Finding
No. 6.) The same rule has since been applied in a num-
ber of valuations made by H. L. Gray, the chief engineer
of the Commissi<Hi.
§ 372. Texas, Michigan and Wisconsin railroad appodsab.
No specific allowance was made for '^ adaptation,"
^'solidification" or ^'seasoning" in tke state raitooad ap-
praisals of Texas, Michigan or ^^sconsin. The Texas
appraisab have been i»imarily for capitalization purposes,
while those of Michigan and Wisconsin have been foa* tax
purposes. Mr. Thompson, then engineer to the Texas
Railroad Conunission, in a paper before the American
Society of Civil Engineers,' says:
*See Second and Third annual reports of the Washington Railroad
Commiasion, 1907-1908, pp. 127, 288.
* Method used by tlie Railroad Comnuanon.of Teias under the atook
Digitized by VjOOQ iC
§ 3721 Adaptation and Solidipication 313
The writer, certainly, is not one to contend that ''season-
ing'' of the roadbed of a railroad does not in a sense add to its
physical value. It is valuable in many ways, viz., the main-
tenance charges per mile are less, the danger of accidents is
decreased, the wear and tear on rolling stock is less, etc. But
the question to be decided by the Commission, when estab-
lishing its methods d valuation, was whether or not such value
was mortgageable, and, if so, how could its value be ascertained.
The expense of "seasoning" is properly charged, through
roadbed account, to maintenance, and does not appear in
the "permanent improvement" or "capital" accounts. It
involves no additional outlay of capital by the owners of the
road, in the sense that other permanent improvements do, and
hence is not value that should be mortgaged; that is, interest
charges should not be permitted to be collected thereon. In
accordance with the decisions of the Federal Courts, the Com-
mission must permit sufficient rates on freight to enable the
railroads to earn, in addition to operating and maintenance
expenses, a fair rate of interest on the value of the property.
Had it recognized that "seasoning of roadbed" was an item
which must be valued in determining the amount of stock
and bonds which a railroad could issue, it would have been
in the position of imposing a double charge on the public on
account of such value, viz., the original cost of such "season- .
ing " and an annual interest on such cost.
Henry Earle Riggs, an engineer connected with the
Michigan railroad appraisal, states in his paper on Vahia-
tion before the American Society of Civil Engineers, that
in the Michigan appraisal, while no special allowance was
made, nevertheless the cost of adaptation and solidification
was considered. He intimates at page 1419, that a portion
of such cost was taken care of in the contingency allow-
ance of 10%. He also says (at page 1515): ^
and bond law in valuing railroad properties, by R. A. Thompflon, in Trans-
actions American Society of Civil fingineera, vol. 52, pp. 328, 362 (1904).
* Proceedings American Society of Civil Engineers, November, 1910.
Digitized by VjOOQ IC
314 Valuation [§ 373
There can be no reasonable objection to adding to the con-
tract 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 three or four years of operation in order
to bring it up to the proper operating condition. A very con-
siderable part of the money spent on ''maintenance of track"
for the first few years after a new line is built is in reality de-
ferred construction cost.
§ 373. South Dakota railroad appraisali 1910.
Carl C. Witt, Engineer to the Board of Railroad Com-
missioners of the State of South Dakota, in his Report of
the appraisal of the railroad properties in the state, dated
October 1, 1910, discusses this question as follows (Annual
Report South Dakota Railroad Conunission, 1910, page
31):
Nothing is allowed for the item known as "adaptation and
soUdification of roadbed " except as reflected in the condition
of the roadbed and ballast at the time of making the inspec-
tion. This item has been given considerable prominence re-
cently in values placed by railway companies and others en-
gaged in making railway appraisals and is added because of
the work done in repairing the damage to track in line and
surface due to settlement of embankments, the cost of clear-
ing out ditches and cuts, etc., etc. While there is no ques-
tion that such expense is necessary, it is an item properly
chargeable to maintenance and is so charged by the operating
railway companies and paid for out of the revenues the same
as renewing worn out ties, and should not constitute an item
of physical valuation. The fact that this work is necessary
proves that there has been depreciation in the physical condi-
tion of the track, due to the action of the elements and the
poimding of the trains, and this depreciation has to be met
until the embankment becomes solid. The very most that
could be allowed would be that the roadbed is maintained at
one hundred per cent.
Digitized by VjOOQ iC
§374] Adaptation and Solidification 315
The above discussion is supplemented by Mr. Witt in his
discussion of a paper by Henry E. Biggs on valuation of
public service corporation property, in Proceedings of
American Society of Civil Engineers, January, 1911,
page 122:
Generally, when a roadbed is turned over to the operat-
ing department by the construction department, it is in good
line and surface, and if an appraisal were made at that time its
condition would be 100%; but as soon as it is placed under
traffic, it begins to depreciate, as shown by the fact that it
requires constant attention to keep it up. If the roadbed is
cross-sectioned at each station and actual quantities calcu-
lated from cross-section notes, there would be no deprecia-
tion, but if the grading quantities are calculated from pro-
files of the line, as constructed some time previously, and for
a standard width of sub-grade, with a percentage added for
shrinkage, and allowance made where banks have been widened,
etc., it will probably be found to exceed the actual measured
quantities, because the action of the elements in washing the
slopes, the wearing of the shoulders of the embankment due
to foot traffic, etc., will show some depreciation in quantities.
It is common practice to carry the item for grading over to
the present-value column at 100%, or, with no depreciation.
This practice, together with the present condition of the
ballast due to maintenance, and that part of contingencies
which covers washing of slopes, filling of ditches, sink holes,
etc., certainly takes care of all adaptation and solidification
which should enter into a valuation of physical property.
§ 374. Appraisal of N. T., N. H. & H. R. R., 1911.
Under the authority of a special Massachusetts Com-
mission, an appraisal was made in 1911 of the property of
the New York, New Haven and Hartford Railroad C!om-
pany with a view to determining whether the company
was over capitalized. George F. Swain, the engineer in
charge of the valuation says (at page 82) : ^
* Report to the Joint Board on the validation of aaseto and liabilities of
Digitized by VjOOQ IC
316 Valuation [§ 374
It is quite customary in the valuation of a railroad prop-
erty to include an item for so-called adaptation and solidi-
fication. This is intended to take account of the fact that
after the road is opened, the embankments will settle, the
slopes will slide in, the ditches become obstructed, and various
other changes take place, requiring an annual expenditure
for maintenance for a number of years, which should properly
be charged to capital. How much this charge should be is
exceedingly uncertain. In the Minnesota valuation, out of
a total estimated cost of reproduction new, for road and struc-
tures, of about $282,000,000, this item was allowed for in
the engineer's report at a figure of $11,743,000, or about 4
per cent. The total cost of grading was estimated at about
$56,000,000, so that about 20 per cent, of this was allowed
for solidification. This item is certainly a real one, and should
be included. The only question is as to its amount. I have
taken it at the very low figure of $500 per mile, which means
that, taking interest at 6 per cent., and supposing that the
annual charge continues for five years, at the expiration of
which time the roadbed has become fully seasoned and no
further charge need be made, there would be an amiual ex-
penditure of about $110 per mile for these five years. This,
it will be seen, is a very low charge. The annual cost per mile
during the first years of operation necessary to take care of
the settlement, slips, etc., in excess of the usual cost of main-
tenance on a seasoned roadbed would certainly be more than
this. The total figure for this item is $805,000. Comparing
with the Minnesota estimate, 4 per cent, of the total for road
and structures would be about $8,000,000, while 20 per cent,
of the cost of grading would be about $6,000,000. The figure
given is certainly low.
The allowance in this case amounts to 2.6% of the cost
of grading, while in Washington the rule is to allow 10%
the New York, New Haven and Hartford Railroad under Chapter 652,
Acts of 1910, by George F. Swain, Engineer in Chaiige. Published in Re-
port of the Massachusetts Joint CommisBion on the New Ycurk, New &iv«i
A Hartford Railroad Company, February 15, 1911, pp. 61-154.
Digitized by VjOOQ IC
§375] Adaptation and Solidification 317
and in the Minnesota appraisal of 1908 about 20% was
allowed. In the latter case, however, the allowance covers
adaptation of the physical Une as well as solidification of
the grading.
§ 376. Texas Railroad Rate Cases, 1892-1898.
In a Texas railroad rate case, Mercantile Trust Co. v.
Texas & P. Ry. Co., 51 Fed. 629, 537, decided August 23,
1892, Circuit Judge McCormick in issuing a temporary
injunction, speaks of the seasoning process as follows:
In the race to occupy territory, or to avail of the state's
donations of land, or to get a basis for the issuance and placing
of their bonds, or to meet the crying want of communities
along their projected lines, or for one, or more, or all of these
considerations, the defendant railways hurried the construc-
tion of their lines, and opened them for business in a green and
unfinished Condition, with unseasoned roadbeds, ties, rails,
culverts, and bridges, and rolling stock not adequate to move
or bear the weight of their present traflSc, and with very little
terminal and way-station equipment. That in large sections
of the state through which these railways pass, the most fertile,
fully occupied, and developed, and furnishing the bulk of their
domestic freight and passenger traffic, the character of the
soil is such as renders it extremely difficult and expensive to
construct and to maintain a sound roadbed, and to keep the
ties on top of it; time and use and constant large additions
to the dump being required, and these not always efficient.
That the cost of construction and equipment up to the time
when these roads were respectively opened for business was
far short of the proper cost of their plant as it exists to-day.
That this proper cost of their plant as it exists to-day exceeds,
in the case of each of these railways, the amount of its bonded
indebtedness. That these roads could be duplicated only by
going through a similar process of seasoning, and that even
with the present reduced market value of much of the con-
struction and equipment material, and the advantages of
transportation of the same to interior points, which existing
Digitized by VjOOQ IC
318 Valuation v [$376
roads would furnish, such duplicates, with equal right of way,
roadbed, track, rolling stock, terminal and way-station fa-
cilities, could not be acquired and constructed now for less
money than these roads have cost.
In the case of Metropolitan Trust Company v. Houston &
T. C. R. Co., 90 Fed. 683, 687, decided December 1, 1898,
Circuit Judge McCormick again refers to the matter of
seasoning. This is an injxmction proceeding involving
railroad rates adopted by the Texas Railroad Commission.
He says:
It seems to be clear .... that in estimating the value
of this railroad property no allowance was made for ... .
the increment to its value due to the settling, seasoning, and
permanent establishment of the railways, .... all of which
ought reasonably to be considered in tixing the value of the
property and the capitalization upon which at Wast it is en-
titled to earn, and should pay, some returns by way of interest
or dividends.
§376. Oklahoma Railroad Rate Case, 1910— Physical and
commercial adaptation.
In the Oklahoma railroad rate case, Missomi K. and
T. Ry. Co. V. Love, 177 Fed. 493, decided February 14,
1910, Circuit Judge Hook refers to physical and com-
mercial adaptation as follows (at page 496) :
An established railroad system may be worth more than
its original cost and more than the mere cost of its physical
reproduction. . . . The inevitable errors in its building which
finite minds and hands cannot avoid have been measurably
corrected, time and effort have produced a conmiercial adjust-
ment between it and the country it was intended to serve,
relations have been established with patrons, and sources of
traffic have been opened up and made tributary. In other
words, the railroad, unlike one newly constructed, is fully
equipped and is doing business as a going concern.
Digitized by VjOOQ IC
§377] Adaptation and Solidification 319
§ 377. Minnesota Railroad Rate Case, 1911.
In the case of Shepard v. Northern Pacific Railway Co.,
184 Fed. 765, 810, decided April 8, 1911, Circuit Judge
Sanborn says:
There are exceptions because the master allowed to the
Northern Pacific Company $1,613,612.76, to the Great North-
em Company, $3,219,642, and to the Minneapolis & St. Louis
Railroad Company $608,896.43, for the solidification and
adaptation of their respective railroads, and deducted nothing
from the cost of reproduction for depreciation. But these
amounts are those allowed by the defendants' engineer and
witness Morgan in his original estimates of the cost of repro-
duction which he reported to the Commission, and there is
much other evidence in the record to sustain them. It is
clear that a new railroad may appreciate or depreciate as it
grows older. It may be renewed, repaired, and improved
day by day and year by year as it is operated, until its em-
bankments become more solid, its culverts and bridges firmer
and more reliable, its ties and rails more steadfast and secure,
and its rolling stock more seasoned and better adapted to its
service and to the railroad it traverses, and until the whole prop-
erty becomes more valuable than it was when it was first con-
structed. On the other hand, its embankments and its road-
bed may be neglected and permitted to deteriorate by the
action of rain, snow, and frost, its ties may be allowed to be-
come partially decayed, its bolts and rails loose, and its rolling
stock worn, without adequate repairs, until the entire prop-
erty suffers great depreciation. Whether at a given time a
railroad property is more or less valuable than it would be if
it had just been constructed is a question of fact, that in a suit
of this nature must be answered by the evidence. That evi-
dence in this case is that the railroads, rolling stock, and ap-
purtenances which constitute the great transportation machines
of these companies in Minnesota are in better condition for
use, more efficient, more steadfast, better adapted to each
other, than if their construction was just completed, that all
depreciation has been offset by appreciation, and that values
Digitized by VjOOQ IC
320 Valuation [§ 378
to the amounts here allowed by the master have been added to
the values of these properties new, by their age, their repairs,
their renewals, their adaptation, and the assured efficiency
that comes from constant careful maintenance and operation.
There was no error in these allowances.
That adaptation and solidification may in a railroad sys-
tem cause an actual appreciation of structural value
sufficient to make good all depreciation throughout the
entire system and leave a large surplus of appreciation, is
a somewhat novel doctrine.
§ 378. New York Railroad Tax Case, 1911 --Seasoning dis-
allowed.
People ex rel. New York, Ontario & Western Railway
Company v. Shaw, 143 App. Div. (N. Y.) 811, 128 N. Y.
Supp. 177, March 8, 191 1, is a case involving the assessment
of a raihroad right of way in a New York tax district. Re-
production cost was accepted as the measure of value for
the purposes of this case. An allowance for solidification
of embankment was rejected. Judge Kellogg in deliver-
ing the opinion of tl» oourt says (at page 814) :
The alleged appreciation of embankment was properly
disallowed. One of the witnesses for the assessors claimed
that there was a gradual shrinkage and filling in from time to
time and such shrinkage might approach 10 per cent. The
relator's witnesses quite well establish that this item was already
allowed for in the other items of shrinkage and in the items
allowed for extra excavation.
§ 379. Irrigation Rate Case^ 1911— Claim for solidification of
earthwork rejected.
San Joaquin and Kings River Canal and Irrigation
Coii^)any v. Stanislaus County, 191 Fed. 875, 881, 885,
decided September 18, 1911, is an action to enjoin the
enforcement of water rates fixed by county boards of
Digitized by VjOOQ IC
§ 37&I Adaptation and Solidification 321
supervisors.^ In this case there was a claim for depreciar
tion in the value of the earthwork amounting to $129,365.
This claim was based largely on the fact that the loss of
water through seepage is less in an old canal than in a new
canal. The claim was, however, disallowed. Circuit
Judge Morrow says (at pages 881, 886) :
The compliunant claimed that the earthwork had appre-
ciated in value in the sum of $129,365, and that this sum
should be added to the cost of reproduction. The master re-
fused to allow this claim. His reasons for so doing cannot be
better stated than as set forth in his report. He says :
''Complainant also claims that the earthwork had actually
appreciated in value, effectiveness, and earning power by the
lapse of time, by reason of the packing of the banks and the
silting of the canals, thus avoiding breaks and preventing loss
of water by seepage. The only witness produced by complain-
ant to show the value of such alleged appreciation is Mr. Ham-
mett, complainant's engineer. The testimony is somewhat
lengthy on this point. I shall endeavor to state Mr. Hammett's
theory of the alleged appreciation and his method of computing
its valuation. He advances the proposition that a newly
built canal is less effective than an old canal by reason of the
greater amount of seepage and loss of water than a new canal,
due to the looseness of the soil, due to the banks not being
compacted, and causing washouts and 'blowouts' as it is called,
making a new canal rather precarious of operation; that, after
it has been operated a few years, it gets in condition; that it
stays about the same from year to year, caused by the fact that
the walls and the floor settle, and the silting, so that both seefH
age and leakage from the gates are largely stopped. ... As
Mr. Hammett takes the total value of the water lost during
these eight years as representing the increased value of the
'A temporary injunction had been granted (San Joaquin and Kings
River Canal k, Imgation Company v, Stanislaus County, 163 Fed. 567).
Subeequently the case was referred to a special master and the master
r^wrted in favor of the legality of the proposed rates and this finding is
in the present case approved by the Circuit Court.
21
Digitized by VjOOQ IC
"322 Valuation [§380
canals in their present condition, it seems to me he should
deduct from the value of such water the cost of canal cleaning
during a period of eight years, which is now required to keep the
canals up to their normal efficiency. In other words, if a new
canal lost $100,000 worth of water in eight years, but needed
no canal cleaning, and an old canal lost no water, but required
$100,000 for canal cleaning, the revenue derived would be the
same. Complainant expended for canal cleaning and dredg-
ing from 1900 to 1908, $80,984.76.
''After a careful examination of all the testimony on this
question, I find I am unable to make either a calculation as
to appreciation or depreciation of the earthworks of the canal,
and shall assume that the one offsets the other."
After carefully reading the testimony on this subject, I have
reached the same conclusion the master did with respect to
this claim.
§ 380. Adaptation of street railway— New York PubUc Service
Commission^ First District, 1912.
Re Bond Issue of N. Y. and North Shore Traction Com-
pany, 3 P. S. C. 1st D. (N. Y.) 63, decided February 13,
1912, involves the approval of the capitalization of a new
electric railway by the New York Public Service Com-
mission for the First District. In the valuation for this
purpose the Commission refused a claim for experimental
operation but included an allowance for adjustment of
power plant. Commissioner Maltbie in delivering the
opinion of the Conamission says (at pages 84, 85) :
The applicants argued that, although the entire system was
''put in full op)eration, December 1, 1910," interest and operat-
ing expenses for several months thereafter should be paid out
of capital upon the ground that the operation was experi-
mental. . . •
It is obvious that the capitalization of operating charges,
after the road has been opened for public use and the con-
struction period ended, can not be defended. Schedules must
be changed constantly, and cars must be routed differently
Digitized by VjOOQ iC
§380] Adaptation and Solidification 323
from season to season and from year to year. No sooner has
the service been adjusted to certain conditions than the condi-
tions change and service must again be readjusted. Experi-
mentation must go on continually.
The method suggested is dangerous, as it opens the door to
over-capitalization. Who is to decide when the company shall
cease to charge operating expenses to capital, and how is it
to be determined? If it may go on for six months as requested
in this case, why not for a year; why not until the road has
reached its maximum capacity? If operating charges may be
capitalized, why not unearned dividends, and why not pay
dividends by issuing securities? Fortunately, the law does
not permit such things to be done. It is evident that when
one has embarked upon this sea, he is soon sailing without a
compass.
The proper solution is to charge all current expenses incurred
after public operation b^ins to income account and later,
when receipts will permit, to distribute a sufficient amount
in dividends to equal a fair return not merely for the current
years but for the early years when profits were lacking.
In the vouchers already considered as representing the actual
cost of the Hicksville, Flushing and Whitestone lines, there was
included about $3,000 as a development expense, represent-
ing the cost of adjusting the power plant. The applicants
claim that certain other expenses should likewise be trans-
ferred to this heading. It is impossible to say what the exact
amount should be, as the records have not been kept in a man-
ner which will permit accurate segregation. It is believed,
however, that a fair estimate would be $3,000. This being
allowed, the books must be altered accordingly.
Re Metropolitan Street Railway Reorganization, 3 P. S.
C. 1st D. (N. Y.) 113, 170, decided February 27, 1912,
relates to the capitalization of a reorganized company.
In regard to adaptation and related matters the Com-
mission says:
Before reaching a final conclusion upon the amount to be
Digitized by VjOOQ IC
324 Valuation [§ 380
allowed, it is advisable to note certain general principles. It
is undoubtedly true that an undertaking is of more value
after it has been operated for a short time and the various parts
have been adjusted each to the other by experimental and
trial operation. The expenditures necessary to bring about
this result ordinarily accrue either before public operation
begins or immediately thereafter, and whenever a part of the
plant is renewed the necessity of adjustment and trial operation
appears. Whenever a new power station, for example, is con-
structed to replace the old one, the company must go through
the same procedure as it did when the old station was originally
started. The same is true of the operating staff. New motor-
men and conductors must be trained to their work, and those
who determine how the plant and cars shall be operated must
experiment before they know what service will best suit the
needs of the community.
Many of these elements are transitory or recurrent. Experi-
mentation must go on continually. New methods and in-
ventions constantly appear, and these must be tested to de-
termine their usefulness and adaptability. Traffic is con-
stantly changing, usually from season to season and from year
to year. The information collected regarding one period of
operation soon becomes useless, because ccmditions have
changed.
In so far as these elements are transitory and call for ex-
penditures year after year, it is obvious that they should not
be paid out of capital, but should be charged as part of operat-
ing expenses. The former practice would lead to over-capitali-
zation. The latter is the sound and prudent course, and the
one followed by conservative managers. It follows that if these
expenses are operating charges, they should not be included
in the fair value of the property. . . .
So far as the information and experience referred to is per-
sonal, it does not and cannot go with the property. It apper-
' tidns to the individual manager or superintendent, and when
he leaves he carries it with him. A company may be able to pay
large dividends because it receives from its employees more
than it pays them^ but it is certainly improper to capitalize
Digitized by VjOOQ iC
§ 381) Adaptation and Solidification 825
the experience or ability of employees. Further, in view of
the conditions which brought about the appointment of re-
ceivers and the present status of the Metropolitan system,
it is not possible to conclude tiiat the system is being opiated
in such a way as to warrant an appraisal of values upon this
score.
In this case the allowanoe for adaptation was considered
in connection with claims for going oonoem value and
expense of promotion and preliminary organization. The
Commission concludes as follows (at page 173) :
After considering all the opinions and peculiar facts rdating
to this system it is the opinion of the Commission that a sum
of from $5,000,000 to $7,000,000 for development expenses in
addition to the amounts already allowed .... is amfde to
cover promotion expenses, preliminary legal fees and techni-
cal services, adjustment of plant and all other elements which
should be included.
§381. Alabama RaihxMid Rat» Cases, 1912.
Special Master W. S. Thorington in his reports in the
Alabama Rate Cases makes an allowance for solidification
and seasoning of roadbed. He fixes the appreciation due
to this cause at 10% of the cost of the grading in the case
of the Central of Georgia Railway Company and at 25%
of such cost in the case of the Western of Alabama Rail-
way Company. In the latter case he says (at page 85) : ^
Mr. Bonnyman is shown by the testimony to be Chief En-
gineer and General Manager of the Atlanta, Birmingham &
7 Western of Alabama Railway Company v. Railroad Commission of
Alabama, United States District Court, Middle District of ^abcuna,
Northern Division, Report of Special Master W. S. Thorington, April 3,
1912; Central of Georgia Railway Company v, Raihoad Commission of
Alabama, United States District Court, Middle District of Alabama,
Northern Division, Report of Special Master W. S. Thorington, Janu-
ary 8, 1912.
Digitized by VjOOQ IC
326 Valuation (§ 382
Atlantic Railroad. ... It is fairly deducible from the testi-
mony of this witness that when a railroad is built and said to be
finished, the work of putting it into shape and operation is but
just commenced; a process of settling goes on through many
years; that it requires a number of years for the roadbed to be-
come settled and for nature to sod and protect it; that a 14 or
16 foot roadbed may be built, yet, before it is operated a year
many of the embankments will work back almost to the ties;
they are weathered oflf, and worked off, and must be continually
renewed. This process continues on the sides of embankments,
and, in the settling process which is continually going on, it is
necessary to keep renewing the roadbed. It is also shown in
bis testimony that the Atlanta, Birmingham & Atlantic Railroad
has steam shovels at work on its roadbed after five years of
original construction and expects to have work for the shovels
some two or three years longer before its railroad bed is in the
shape of that of the Western Railway, so far as the width and
permanency of the roadbed are concerned. And that during
the process of settling the road is continually getting down on
one side or the other, and there is no way to get a good track
except from the rains falling on it, and running the trains on it,
and by the continual putting it up, and keeping it up, until,
finally after some years there is a settled roadbed.
§382. Summary.
As indicated above special allowances for adaptation,
solidification or seasoning have been made in railroad
appraisals in Minnesota and Washington, in the Mas-
sachusetts appraisal of the New York, New Haven and
Hartford Railroad and in the report in the Alabama
Railroad Rate Cases. In Washington and Massachu-
setts the allowance is clearly limited to the solidification
or seasoning of the grading while in Minnesota it covers
also adaptation which is defined as ^'the adjustment of
the physical line to its environment and piuposes."
"Adaptation" and "solidification" as applied to road-
beds are also applicable in some degree to other structures
Digitized by VjOOQ IC
§382] Adaptation and Solidification 327
and particularly to extensive public utility plants and
systems. This is sometimes referred to as the dement of
value arising froni an ''adjustment of parts" or irota the
'^tryinjg out^' of the plant. It is recognized that it is im-
possible to plan any large system so carefully and in such
detail that it will actually meet the demands upon it
without a great many alterations and additions. Actual
use will bring to li^t numerous imperfections and will
show the need of many readjustments. It may be said
that the construotion period does not actually end until
these readjustments have been made. Considered in this
way, expenditures for adjustment and solidification are
a proper charge to construction cost. They are of the
same nature as items included under the head of contin-
gencies in estimating cost and some estimators enlarge
the contingency allowance to include at least a part of the
probable expenses for adjustment, adaptation and solid-
ification after construction is nominally complete. As a
matter of fact, expenditures for adaptation and solidifica-
tion are usually charged not to construction but to opera-
tion. In the case of solidification of roadbed it would
seem that it would be very difficult to say what part of the
expenditures for maintenance of the first few years could
be properly considered an addition to capital value and
what part was purely an operating expense. Other ex-
penditures for adaptation and adjustment would be very
difficult to distinguish from supersession due to inad-
equacy or obsolescence. But however this question may
be taken care of in the accounting system, it is clear that
the fact that a plant or railroad has passed through the
initial period when expenditures are necessary for adapta-
tion-and solidification adds to its physical structures an
element of value. Anything that tends to decrease the
current charges of an old structure as compared with such
charges for a new structure tends to increase the present
Digitized by VjOOQ IC
328 Valuation [§ 382
value of the old structure as compared with the value of
the new structure. If fair value is based on present com-
mercial or market value of the physical structures, any
actual appreciation through adaptation or solidification
will necessarily be considered. If fair value is bassd not
directly on money value but on cost or the ratio that re-
maining utility bears to original or reproduction cost less
salvage value, the same conclusion is reached. The
difficulty in application arises from the danger that this
item will be included both in operating e3q[)enses and in
fair value for rate purposes.
Digitized by VjOOQ iC
CHAPTER XVII
Physical Depreciation
i 390. Depreaation problem.
391. Physical depreciation and functional depreciation.
392. What is depreciation?
393. Other definitions.
394. Straight line method of measuring depredation.
395. Sinking fund method of measuring depreciation.
396. Sinking fund method discussed.
397. Present worth method of measuring depreciation.
306. Present worth method applied to a class.
399. Present worth method applied to system as a whole.
400. Other methods of measuring depreciation.
401. Uniform investment cost method of adjusting depreciation.
402. New York Public Service Commission, Pint District, rejects sinking
fund method.
403. Straight line method in New York City Street Railway Fare Case.
404. Depreciation rule contained in uniform water supply accoimts, 1911.
405. Depreciation of overhead charges.
§390. Depreciation problem.
Having determined the eo8tK)f-reproduction-new it re-
mains to determine the relation of the existing property
to this factor. There is no doubt that worn rails because
of their shorter remaining life have a smaller total utility
and a smaller money value than new rails. A company
can afford to pay more for new cars and new rails than
for old. Depreciation is however one of the most difficult
and elusive problems connected with valuation. It is
not necessary for the purposes of this book to attempt a
complete discussion of the subject but merely to consider
it to such extent a^ may be necessary to determine its
general relation to valuation for various purposes. In
venturing to discuss this problem the author realizes that
the result must be incomplete and tentative.
[329]
Digitized by VjOOQ IC
330 Valuation [§ 391
§ 391. Physical depreciation and functional depredation.
Depreciation may be divided into two general classes:
(1) physical depreciation, (2) functional depreciation.
Physical depreciation is the result of deterioration due
to wear or to age. It results from use, decay, and the
action of the elements. Functional depreciation is the
result of lack of adaptation to function. It results from
changed conditions and surroundings which render the
structure ill adapted to its work; from growth of the busi-
ness which renders the structure inadequate or to decline
of business which renders it too large; from the develop-
ment of the art which makes desirable the substitution of
other methods, equipment and structures. The terms
inadequacy and obsolescence are often used to denote in
part what is here termed functional depreciation. Phys-
ical depreciation is a constant factor; it begins as soon as
the structure is exposed to the action of the elements or
is put to use. Functional depreciation is fortuitous; it
may come into play diuing the lifetime of a particular
structure and it may not.
§ 392. What is depreciation?
Although there is substantial agreement as to the cause
and existence of depreciation there is little agreement as
to what depreciation really is and much less agreement as
to the correct measure of depreciation. Is depreciation
(1) a lessening in money or market value or (2) a lessening
in utility value or (3) merely the necessary adjustment to
secure a uniform investment cost? Perhaps the term
depreciation like the term valuation is somewhat indef-
inite unless used with reference to some particular pur-
pose. It is generally agreed that valuation for purposes
of private purchase or sale has important elements of
difference from valuation for public purchase, or for rate
making (see Chapter I). Probably similar elements of
Digitized by VjOOQ iC
§ 392] Physical Depreciation 331
difference exist in an estimate of depreciation when made
for the varying pmposes of private sale, public purchase,
rate making, accounting, capitalization or taxation. In
case of voluntary purchase or sale depreciation is naturally
considered as lessened money or market value. As thus
considered and applied to physical structures deprecia-
tion may be defined as the lessened money wlue caused
by physical deterioration or lack of adaptation to func-
tion.
But according to approved rulings, fair value for rate
purposes is not based on market value but largely on cost,
either actual cost or reproduction cost. Cost seems more
closely related to actual utility than to market value.
The cost as a factor in rate regulation represents the total
utility to be secured from the unit in question. As this
utility is used up with the wear and age of the unit, the
cost or fair value may be said to decline in the same ratio.
Prom this point of view depreciation can be defined as the
lessened vUlity value caused by physical deterioration or
lack of adaptation to function. There is also another
factor that deserves careful consideration and is possibly
controlling. The supply of a public service is a contin-
uous enterprise. The rights of the consumers using the
service at different periods demand that the annual
charges attributable directly to the investment shall be as
uniform as possible. These annual charges include not
only interest and profits on the investment but also the
annual expenses for the repairs, renewals and replace-
ments necessary to keep the property in good working
condition. This annual investment cost may be made uni-
form by proper depreciation adjustments. Is this not the
logical function of depreciation in the theory of rate regu-
lation? Use the depreciation factor so as to secure as low
a uniform annual investment cost as is consistent with
justice to the investor.
Digitized by VjOOQ IC
332 Valuation [§ 393
§ 393. Other definitions.
Utility value relates to the total work that will be per-
formed during the remaining life plus the scrap value.
Operating efficiency relates to present efficiency as an
operating unit without regard to future service or length
of remaining life. Scrap value is the money value for
which a plant unit may be sold when it is no longer desir-
able to retain it in service. Wearing value is the difference
between cost and scrap value. Present value is the term
usually used to denote the difference between cost-of-
reproduction-new and the existing depreciation. The use
of this term to denote what is largely cost rather than
value seems an added source of misunderstanding in an
already sufficiently confused assortment of terms. The
author has therefore used instead of present value the
less convenient phrase co8t4e88-depreci(Uion or cost-of-
reproduction-lessndepreciation.
Althou^ physical depreciation is based on physical
deterioration the two terms are not identical. A half
worn rail has a 50% deterioration in wearing value but
not necessarily a 50% depreciation oi wearing value based
on either money value or utility value or uniform invest-
ment cost. Depreciation represents the loss in value due
to actual deterioration but the percentage of deterioration
may or may not be the same as the percentage of depre-
ciation in value. Moreover a rail may have a 50% de-
terioration or depreciation and at the same time have
100% operating efficiency.
§ 394. Straight line method of measuring depreciation.
Under the straight line theory it is assumed that the
wearing value decreases uniformly each year during the
assiuned life. If the assumed Ufe is ten years and six
years of such life have elapsed, the existing depreciation
amounts to six tenths of the total wearing value. This
Digitized by VjOOQ IC
§ 394] Physical Depreciation 333
method is the one most largely used in appraisals for all
purposes. It has the merit of simplicity. It is particu-
larly simple when what is known as the 50% method can
be applied. If the life of a street car is twenty years and
the ages of the cars to be appraised vary all the way
from one to twenty years, and the number of cars of
each age is the same, the average age of the total car
equipment is ten years, and this is just one*half of the
total life. Assuming that the cars in question have a
uniform cost-new, the depreciation would be 50% of the
total wearing value. When a system has been built up
piecemeal or after a cycle or two of renewals, the cars, ties,
rails, poles, wires, etc., become evenly distributed as to
age. If this is true the estimator can say at once imder
the straight line method that the existing depreciation is
equal to 50% of the total wearing value of these units.
In order that a class of imits may be appraised imder the
50% rule it is necessary that the members of the class be
so numerous that the law of averages can in fact be relied
on. The 50% rule is particularly applicable to certain
classes of railway property and has been used in connec-
tion with certain large street railway appraisals. Under
this rule the problem of estimating the depreciation in all
the steam railways of the country would be very simple.
If the aggregate cost of reproduction of the depreciable
property and the aggregate scrap value of the same were
known, the depreciation would be figured as just 50% of
the wearing value or the difference between cost-new and
scrap value. This would follow because these systems and
their component units are of all ages and of all the de-
preciable structures having for example a ten year life
there are doubtless as many one year old as there are
two, six or nine years old. Even in the case of buildings
and other large or long lived units the number of units is
sufficient and the process of equalization has gone on for
Digitized by VjOOQ IC
334 Valuation [§395
a long enough time to make the application of the 50%
rule sufficiently accurate. The result of this theory is not
so startling in its application to railway values as it at
first seems. The percentage of depreciable property in a
steam railroad is not very large. Land, right of way,
roadbed and many overhead charges are not depreciable.
Moreover the scrap value is quite high. So that the 50%
depreciation of wearing value is in fact only applied to a
small percentage of the total cost of reproduction.
§ 396. Sinking f^nd method of measuring depreciation.
The sinking fund method assumes that an amoimt is
set aside each year which invested at compound interest
will equal the total wearing value at the end of the as-
sumed Ufe. The depreciation at any time is said to
exactly equal the amount that is or should be in a sinking
fund accumulated in this way. Under the sinking fund
method the existing depreciation found is always less
than it would be under the straight line method. The
degree to which it varies will depend largely on the rate
of interest at which the fund is assimied to accumulate.
The higher the rate of interest assumed, the smaller will
be the existing depreciation imder the sinking fimd
method as compared with what it would be under the
straight line method. The difference between the two
methods is not great for a unit with a short life but for a
unit having a fifty year life the excess of the existing de-
preciation as shown by the straight line method over that
shown by the sinking fund method may be enormous.
The sinking fund method may be justified as a simple
accounting method of apportioning evenly a loss which
will not actually accrue imtil the unit needs to be renewed.
The main idea here is the creation of a fund which at the
end of the life of the unit will, together with the scrap value,
equal the cost of renewal. But it is clear that the rate at
Digitized by VjOOQ IC
§396] Physical Depreciation 335
which such funds may accumulate does not bear any
necessary relation to the rate at which either the money
value or the utility value of the unit actually depreciates.
If depreciation is merely a question of money value or of
utility value the sinking fund method has little logical
justification.
§ 396. Sinking fund method discussed.
The Wisconsin Railroad Ck)mmission recognizes that
there is no actual connection between the rate of deprecia-
tion and the rate at which money can be made to accumu-
late in a sinking fimd but says that it seems reasonable
to assume ''that the 4 per cent, sinking fund curve fairly
represents the progress of depreciation under average
conditions." In the case of City of Beloit v. Beloit Water,
Gas and Electric Company, 7 W. R. C. R. 187, 235, de-
cided July 19, 1911, the Commission discusses this subject
at considerable length:
It is frequently assumed, and is strongly contended by the
petitioner in this case, that the rate of depreciation is uniform,
that is, that the decrease in value follows a straight line drawn
between two points, namely, cost of reproduction and scrap
value. While it is true, perhaps, that the physical decay of
equipment begins at the moment it is placed in service, it must,
on the other hand, be acknowledged that very frequently equipn
ment which has been in use for a few months and has proved
its adaptability to the service required of it has a greater value
than the cost new of the untried machine. On the other hand,
conditions are conceived where the equipment shortly after
its installation is worth much less than its value as shown by a
straight line depreciation curve, due to the fact that the equip>-
ment in question is unsuitable or improperly designed, con-
structed or installed. In the majority of instances, however,
it woidd appear that there is only a slight decrease in the actual
value of a unit as operative equipment during the early period
of its life. No maintenance may be required for several years,
Digitized by VjOOQ IC
S36 Valuation [§396
and so far as a superficial examination would indicate, the unit
IB ''as good as new." The fact that numerous instances of
this kind can be pointed out has given use to more or less errone-
ous ideas as to the value of equipment which has been in serv-
ice. . No matter how remarkable the performance of a machine,
a day will come when even the most casual examination will
show that the value falls far below that of a new unit. Main-
tenance increases and efficiency decreases, and a period is
reached when the unit is kept in service only by a large increase
in operating expenses.
The prejudice against second-hand machinery is, to a con-
siderable extent at least, an expression of general opinion that
a machine depreciates more rapidly during the latter part of
its life. It is a common saying that it pays to get the first
wear out of a machine. The price which equipment will bring
second-hand, however, is not indicative of its present or ex-
isting value as an operating unit.
It seems fairly certain, in view of the facts, that if we are to
consider the value of a unit of equipment as installed and in
operation, the depreciation will in general occur more slowly
during the earlier than during the later years of its life, and
that in general the value at all times will be somewhat above
the straight line drawn from cost of reproduction to scrap value.
It is, however, much easier to arrive at this conclusion than
it is to indicate the course actually followed by the decrease in
value. It is probable that the fairest representation of this
course is the sinking fund <;urve. Whether a 4 per cent., 3 per
cent, or other curve is the closest to a fair and reasonable rate
depends largely upon other factors, which can perhaps be
closely ascertained only by careful investigations and clear
knowledge of the surrounding conditions. Where proper de-
preciation curves have been kept in the past, the present or
existing value of a property, as determined by inventory, in-
spection and appraisal, plus the depreciation reserve^ should
theoretically equal the cost new of that property.
There is, of course, no actual connection between the rate
of depreciation of equipment and the rate at which money ac-
ciunulates under a given rate of compoimd interest. The
Digitized by VjOOQ iC
§ 396] Phtbical Depbeciahon 337
progress of depreciation must be assumed in any case. If we
are to follow the proposition that it follows a curve instead
of a straight line, it seems fair to assume that this curved
line has a certain general form, and it would seem reason-
able to assume that the 4 per cent, sinking fund curve
fairly represents the progress of depreciation under average
conditions.
Many appraisers oppose the use of a curve of any kind or
form, and rely upon the judgment of an expert as based upon
the actual inspection of the equipment under consideration.
Since, however, a great deal of equipment cannot be adequately
examined in service, it is necessary to rely very largely upon
age, and in such cases the appraiser actually depreciates upon
an actual or mental curve which is based upon the more or
less definite life table which is the result of his experience.
More consistent and fairer results would appear to be obtained
by the use of a life table compiled from the experience of a
large number of experts in connection with a definite curve,
even if the basis for the tise of such curve rests, to some extent,
upon assumptions which are more or less difficult to justify
with exactness.
If, as stated above, maintenance increases and ej£ciency
decreases with age, thus making it pay to get the first
wear out of a machine, the effect is to miake the first year's
use more valuable than the use of subsequent years.
When three years of a nine year life have expired more
than one-third of the money value or the utility value of
the machine has been used up. Its depreciation should
therefore be more than it would be figured on a straight
line basis and very much more than it would be figured
on a sinking fund basis. The only way that a deprecia-
tion less than that under the straight line method can be
figured is (1) by assuming that maintenance is greater
or efficiency less during the early years than during the
later years, or (2) by considering the effect of some other
factor such as interest on investment or the present
22
Digitized by VjOOQ IC
338 Valuation [§ 397
worth of future advantages and disadvantages, or (3) by
considering the need for a uniform investment cost.
§ 397. Present worth method of measuring depreciation.
Depreciation may be considered from the viewpoint of
the advantage to the user of a hypothetical substitution
of a new article for one that is partly worn. It may be
simmied up in the question, How much could the user af-
ford to pay to have his worn article replaced by a new one?
How much could the company afford to pay to have a
five year old car replaced by a new car of exactly the
same kind? The new car might have five more years of
service than the old car. What is the present worth of
these five additional years of service? The new car could
be operated during certain years with less expense for re-
pairs and maintenance than the old car. What is the
present worth of these possible savings in maintenance
and repair? Moreover the time that a car is out of service
undergoing repairs and the loss due to breakdowns while
in service are important elements in the calculation.
In considering the present value of future gains or
losses a discount for interest during the intervening
period must always be included. No one will pay down
$1,000 either to receive the return of the identical sum
five years hence or to avoid the payment of such identical
sum five years hence. If however money is worth 5%,
he may pay down $1,000 less five years discount cal-
culated on a 5% basis. In other words he will pay the
present worth of S1,000 due five years hence. In the same
way assuming a twenty year life the company owning a
five year old car could afford in exchanging it for a new
car to pay the present worth of the five years of additional
service that it would seciu^ at the end of the fifteen years
of remaining life in its old car. What is the pres^it worth
of five years of service enjoyable at the end of a fifteen'
Digitized by VjOOQ IC
§398] Physical Dbpreciation 339
year period? In the same way what is the present worth
of all the savings in maintenance, repairs and operating
cost starting with a new car as compared with an old?
§ 398. Present worth method applied to a class.
The present worth method of estimating dq^reciaticHi
may also be applied to any class of structure or equipment
as an entirety. Instead of being applied to a single car it
may be applied to the entire car equipment as a single
unit. It is peculiarly adapted to any class of equipment or
structure the individual imits of which are so numerous
that after a time renewals take place in even proportions
and at frequent intervals— cars, ties, poles, rails, etc.
Take for example the entire track equipment and assume
that various portions of the track are in varying stages
of age and wear. Under this method the question is what
cotild the company afford to pay to have its worn tracks
exchanged for new tracks. This would depend on the
savings resulting from the substitution, and such savings
would be measured by the difference in future main-
tenance and renewal charges of a new track system as
compared with the old track.
Starting with all new rails the necessary exp^iditures
for maintenance, repairs and renewals are very small for
a considerable number of years. Then as the average
period of rail life draws near, the expenditures for renewals
become large. After this period is passed expenditures for
maintenance and renewals decline gradually until a prac-
tically constant basis is reached. The track equipment
has now settled down to a constant condition of age and
wear and the cost of maintenance and renewals does not
vary much from year to year. This process of equaliza-
tion will be greatly hastened if the track is built, as is cus-
tomary in large systems, on the piecemeal plan. Whether
the start is made with all new track or with partly worn
Digitized by VjOOQ IC
340 Valuation [§ 399
track, after a time the average condition as to age and
wear will be the same in either case and the subsequent
expense for maintenance and renewals will also be the
same. The advantage of substituting all new tracks may
therefore be measured by the excess of the present worths
of the annual savings over the annual losses in maintenance
and renewal costs prior to the time when the track will
have settled down to a permanent average condition of
age and wear and of maintenance and renewal costs.
There will be a nimiber of years when there will be savings,
then may follow a number of years when the increasing
renewals will cause losses. The present worths of the
savings less the present worths of the losses leaves a sum
which represents the total value of substituting new track
for old. It is a measure of the depreciation in value at-
tributable to the old track as compared with new tracks.
§ 399. Present worth method applied to s]rstem as a whole.
This method of estimating depreciation may also be
applied to the system as a whole. After the various parts
of a large public utility plant have gone throu^ com-
plete cycles of renewal the plant settles down to a condi-
tion in which saving extraordinary fimctional depreciation
expenditures for maintenance, repairs and renewals be-
come practically constant. There is little fluctuation from
year to year and the averages by five or ten year periods
are practically identical. When the plant has settled
down to this condition, What is the difference between its
structural value and the structural value of the identical
plant starting with new structures and equipment?
What could the company afford to pay to have its partly
worn but 100% efficient structures and equipment re-
placed by new structures and equipment having not only
100% efficiency but also 100% wearing value? Obviously
during the first years of operation with new structures
Digitized by VjOOQ iC
§ 400] Physical Depreciation 341
and equipment the expenditures for maintenance, repairs
and renewals would be much less than the average when
the plant is settled down to a practically constant per-
centage of average deterioration due to age and wear.
Then may follow a period when such expenditures are
higher than such average, and finally perhaps after several
minor fluctuations the constant basis will be reached.
This settling down or equalizing process is very greatly
hastened by the fact that large systems are constructed
by piecemeal. The present money value of new struc-
tures and equipment over the old is therefore repre-
sented by the present worth of the annual savings in ex-
penditures for maintenance and renewals less the present
worth of any annual excess in such expenditures, during
the period while the starting system is going through the
cycle of renewals prior to the time when it settles down to
a constant condition of average age and wear and a prac-
tically constant expenditure for maintenance and re-
newals.
So far as known the above method has not been applied
by appraisers in oj£cial valuations. It is however briefly
described and theoretically applied in an imsigned article
in the Tramway and Railway World (London) Novem-
ber 9, 1911. The writer of this article estimates on this
basis the difference between the value of a long established
tramway with partly worn equipment and an entirely
new tramway as between 11.4% and 16.3%. That is, the
long established tramway in good working order has a
depreciation of from 11% to 16%.
§ 400. Other methods of measuring depreciation.
The three methods of measuring depreciation most
used are the straight line method, the sinking f imd method,
and the actual inspection method. The first two methods
are often modified by the actual inspection method.
Digitized by VjOOQ IC
342 Valuation [§ 400
Thmt iSi the appraiser by actual inspection determines the
probable useful life of each particular unit and then ap-
plies either the straight line method or the sinking fund
method* Or he may simply rely on his own judgment
as to what is the actual worth of the worn imit without
the aid of any formal method. Halbert P. Gillette in his
Handbook of Cost Data gives a formula for estimating
depreciation lyhich he calls the ''unit cost depreciation
f onnula." ^ He bases his formula on the following assump^
tkm:
The owner of a second-hand machine is entitled to such a
price for it as will enable the purchaser to go on with its use
and produce each unit of product at as low a cost as the aver-
age unit cost of production would be during the entire life of
the machine.
The underlying theory here is apparently much the same
as that of the present worth method above referred to.
Depreciation is conceived to be the actual lessened money
value to the user of the worn imit as compared with a new
imit. This seems a reasonable standard for purposes of
purchase and sale. But fair value for rate purposes is not
in general based on the market or money value of the
property but on cost and utility. Similarly, depreciation
for rate purposes may perhaps be more appropriately
based directly on the actual decline in utility value of the
physical usdts representeld by cost. In utility value as
distinct from money or market value there is no recogni-
tion of the superior value of present goods as compared
with futiu^ goods which forms the basis of the present
worth method. Depreciation is measured directly by the
percentage of total utility or service already used as com-
pared with the total utility in a new unit. If maintenance
charges and operating efficiency are constant throughout
1 fiatt>ert P. Gilktte, Cost Data, 2d Ed., 1910, p. 36.
Digitized by VjOOQ iC
§401] Physical Depreciation 343
the life of ihe unit, utility value disappears at an equal
rate, u e., on the steai^t line basis. If maintenanoe
charges increase or operating efficiency declines during
the later years, utility value is used up faster in the
earlier yean than during the later years and consequently
we may have a curve of depreciation which is the reverse
of a sinking fund curve.
§401. Uaifdnii iiivestnient cost method of ad justing depreda-
tion.
In even closer conformity to the theory of rate regulation,
depreciation may be treated as the adjustment necessary
to secure a unifOTm annual investment cost. By this is
meant that the annual charge for interest and profits and
for the rqiairs, renewals and replacements necessary to
keep the property in good working order sbsXi be uniform.
It is of course much easier to state this principle than to
apply it. It seems upon the whde the most plausible
theory, yet only fragmentary suggestions can be offered
as to its application. It will ms^e use. in part of the
strai^t line method and in part of the sinking fimd
method and will add to these the additional factor of a
direct amortization of capital.
The determination of annual depreciation requirements
is largely a matter of cost accounting. The supply of a
public service must be considered a continuous process.
The problem is to so arrange the depreciation allowance
that the investment will be carried and kept intact at a
uniform annual cost. The annual investment cost in-
cludes not only interest and profits but also the r^airs,
renewals and replacraaents necessary to keq? the property
permanently in good working condition. If this allowance
is adequate, the rights of the investor axe safeguarded.
If this allowance is determined in the most economical
way, the rights of the consume are safeguarded. A fact
Digitized by VjOOQ IC
344 Valuation I§ 401
of prime importance in the consideration of this question
in connection with a public utility is that the real per-
manent investment must be something less than the cost-
new. After a start with all new structiu^es and equipment
there will never be a return to this condition except in the
case of extraordinary total supersession. Total plant
supersession should be treated as a hazard rather than a
cost (see § 452). As the permanent inv;^tment must be
less than the original investment it is possible to reduce
the permanent annual charge for interest and profits by
amortizing a part of the original investment. It is possible
to do this with justice to the consumers of the earlier
period because in that period the expenditures for re-
pairs, renewals and replacements are less than will be the
later permanent average expenditures for this purpose.
Moreover in view of the fact that such expenditures are
ultimately permanently greater than during the first
period there must be some permanent reduction in the
annual charge for interest and profits as otherwise the
total annual investment cost will not be uniform but will
increase. Other conditions remaining the same, this will
require an increase in the rates of charge. This would be
unfair to the consumers of this period as they are equi-
tably entitled to the same investment cost and the same
relative rate of charge as the consumers of the earlier
period.
It is recognized that a railroad system cannot be kept
in absolutely new condition. Although maintained at
100% efficiency, it will after construction show a greater
and greater percentage of wear imtil it at length settles
down to a practically constant percentage of wear and of
depreciation in value and a practically constant expendi-
ture for repairs and renewals. During the period when
the system is thus settling down, the annual allowance for
depreciation must be adequate to take care of all repairs
Digitized by VjOOQ IC
§ 401] Physical Dbpbsciation 345
and renewals and also to pay back to the owners the
investment that permanently disappears through de-
preciation and will not again be needed in the business.
If when this initial period is over the railroad will per-
manently show 15% depreciation over cost-new, this 15%
should through the annual depreciation allowance already
have been returned to the owners. As for the futiu^,
while the actual expenditures for repairs, renewals and
replacements will be larger than during the initial period,
there will be no further necessity for the amortization of
a portion of the permanent investment and moreover the
annual charge for interest and profits will be less. If the
adjustment has been properly made the total annual in-
vestment cost will be the same as diuing the earlier period.
It is claimed for certain large railway systems that the
annual expenditures for repairs, renewals and replace-
ments have become equalized so that the percentage of
wear is constant and unchanging. Current repairs, re-
newals and replacements take care of all current depre-
ciation and there is no need for an accumulated reserve to
take care of either phjrsical depreciation or the ordinary
amoimt of fimctional depreciation. If this is true the
actual annual average expenditure of the railroad for
maintenance, renewals and replacements becomes the
exact measure of the amoimt needed each year for main-
tenance and depreciation. No fund or reserve is required.
Except perhaps for the very large utility systems the
above condition though approximated is never actually
reached. They have a few large structures having long
lives, so that the percentage of wear and age for the sys-
tem as a whole is not constant but fluctuates somewhat
with the age of these large imits. Nevertheless the total
expenditures for repairs, renewals and replacements
fluctuate only between certain well defined limits. There
is a certain normal expenditure and there are also certain
Digitized by VjOOQ iC
I
i
i 346 Valuation {§402
infrequent extraordinary expenditures in excess of t^
normal. It is only for these infrequent expenditures in
excess of the normal, that it is necessary to provide by
means of a reserve. The amount necessary to meet these
large expenditures should be accumulated by the most
economical method that will evenly distribute the burden.
The sinking fund method seems well adapted for this
purpose.
Under the uniform annual investment cost method the
existing depredation is the amount of the original invest-
ment that has been amortized as a necessary result of the
actual or theoretical application of this method from the
initiation of the ent^rpr^.
§ 402« New York Public Service Comim88ion» First District,
rejects sinktog fund method.
Re Metropolitan Street Railway Reorganization; 3 P. S.
C. 1st D. (N. Y.) 113, 163, decided February 27, 1912,
relates to capitalization aitef reorganization. In estimat-
ing the fair present value of the property tlie commission
rejected the claim that d^n*edation if allowed for at all
should be allowed for on a 5% sinking fund basis. The
basis used by the Commismon was the straight Mae
method. The Commission says (at page 153) :
Notwithstanding the dedsioos of the Commission in other
cases and the questions addressed to the witnesses called by the
applicants, no testimony was presented by tbera to indicate
what allowance should be made for depreciation or what was
the actual value of the physical property at present. They
did submit a statement by one witness to the effect that, even
if depreciation were to be deducted from liie estimated cost-
to-reproduce-new, the amount thus subtracted should not ex-
ceed $7,329,180. This ^ure was reached by fixing an amount
to represent part of the cost of the property as new, a salvage
value, a life table and an age table for the different classeB of
Digitized by VjOOQ IC
§402] Physical DfiPB£ciATiON 347
property. From these assumed facts and the further assump*-
tioii that a sinking fund oould be made to accumulate at 5 per
cent, compound iqterest per annum, the witness found that if
the company had $7,329,130 now in a fund, and if other annual
payments were paid into this fund and compounded at 5 per
cent, annually, the company would have at the end of the as-
sumed life of the property a sufficient sum of money together
mth what might be realized from the sale of the scrap to pro-
vide for the replacement of part of the property aa it now
exi^. . . •
(6) The problem before us is not how to meet and provide
for decrease in values, but what is the fair value of the plant
at present. It may be that sinking funds will provide for the
replacement of the various parts if they live out their allotted
terms, but in the meantime, capital is impaired imless the
value disappears at the same rate that the sinking fund accumu-
lates. As a matter of fact this is true of few classes of property,
and the curves which represent values from year to year are
so varied that rarely does one coincide with the mathematical
formula adopted by ihe witness who estimated $7,329,130 as
the maximum deduction for depreciation. It seems to have
been forgotten that the difference between cost and present
value determines depreciation; depreciation does not fix present
value. How the impairment may be met is a separate ques-
tion.
Mr. Connette, the Transportation Engineer of the Com-
mission, prepared an estimate of present value, which was
introduced in evidence. . . •
The most important ditference between Mr. Cbnnette's es-
timate and the calculation presented by Mr. Uebelacker, which
he declared ''absolutely useless," is that the former foUows
the straight-line method, while the latter adopts the 5 per cent,
sinking fund method. Without going into the technical de-
tsdh of these two plans, suffice it to say that the fundamental dif-
ference is that the former assumes the property to decrease
uniformly in value from year to year, the latter that it follows
parabolic curve. The former assumes that the decrease will
be met year by year as it occurs, that the payment from eam-
Digitized by VjOOQIC
348 Valuation [§ 403
ings will be immediately expended and that it will not accumu-
late at compound intereBt. The latter assumes that nothing
will be spent before the end of the period, that it will all ac-
cumulate and that impairment of capital need not necessarily
be met as it occurs.
§ 403. Straight line method in New York City Street RaUway
Fare Case.
Bion J. Arnold; consulting engineer, made a valuation
of the property of the Coney Island and Brooklyn Rail-
road for the New York Public Service Conunission for the
First District for use in a case involving the fares charged
by that company.^ In testifying as to his valuation in
this case Mr. Arnold explained his method of treating
depreciation as follows:
A. Depreciated Value of Physical Equipment: This value was
obtained under the following instructions: Deduct from the
Cost to Reproduce the Depreciation which may have been
caused- by Obsolescence, Inadequacy, Wear, Deferred Main-
tenance and Casualties. The equipment can deteriorate only
down to its Scrap Value. In obtaining the Present Value of
this part of the property, therefore, consideration should be
given the following items: —
A. Cost to Reproduce including:
Contractor's Profit,
Incidentals,
Administration during Construction, and
Engineering.
B. Scrap Value ,
C. Original Service Value.
D. Depreciation due to Obsolescence, Inadequacy and Age.
E. " " " Normal Wear.
F. " " " Deferred Maintenance & Casualties.
G. Remaining Service Value.
* Monheimer v. Coney Island and Brooklyn Railroad Company, 1
P. S. C. Ist D. (N. Y.) 705, July 2, 1909.
Digitized by VjOOQ IC
§403] Physical Depreciation 349
H. Present Value, as follows:
C-A minus B.
G -C minus (D plus E plus F).
H=GplusB.
B. Scrap Value: is determined by allowing a fair market
price for the material as scrap, less the cost of turning it over
to the dealer.
C. Original Service Value: is the difference between the Cost
to Reproduce (A) and the Scrap Value (B). Depreciation was
considered as taking place only on the Original Service Value.
Scrap Value does not depreciate.
D. Obsolescence, Inadequacy and Age: There is a class of de-
terioration which cannot be prevented by maintenance, or
offset by repair. Obsolescence which results from a "change
in the art," Inadequacy, due to the growth of the business and
the natural result of Age are examples of depreciation, which
can only be taken care of by complete replacement, and should
therefore be provided for by means of a renewal, reserve or
amortization fund.
This fund should equal the Original Service Value of the part
by the time it becomes of no operating value. If the amount
that should be in this reserve fund at any time is determined,
then this amount is a proper measure of the depreciation due
to the above causes, which has occurred up to that time.
There are a number of possible methods which may be fol-
lowed in determining the amount which should be annually
allowed for a reserve or amortization fund for each part of the
property which is subject to Obsolescence, Inadequacy and
Age — ^but for the purpose of this appraisal, the simplest and
most direct method has been adopted. This method consists in
deciding upon a probable time when each part of the property
shall be of no operating value; that is, reduced to scrap. Di-
viding 100 by this length of life in years gives at once the annual
percentage or rate per year of depreciation from these causes.
The product of this rate, the elapsed life of the part, and the
Original Service Value, equals the deduction to be made for
Obsolescence, Inadequacy and Age. If a reserve fund has not
been provided to offset this Depreciation, then a deduction
Digitized by VjOOQ iC
360 Valuation [§403
of the amount should be made from the Cost to Beproduce
when determinmg Present Value.
E. Normal Wear: The Normal Wear of any part is the de-
terioration of that part due to service or the action of the ele-
ments, and should periodically be offset by proper and regular
maintenance and repair. This Wear may be considered as
^^ Normal" down to the point where economy of operation or
adequate service dictates repair— if allowed for any reason to
wear— beyond this point continued wear tneans Neglect or
Deferred Maintenance. A depreciated condition of the system
as a whole, however, must ordinarily exist from Normal Wear,
due to the fact that wear on the system as a whole, which occurs
gradually, can, as a rule, be offset only periodically, and there
will be an appreciable period of time between the actual wear
and the removal of its effect from the system.
The measure of this normal wear is best determined by a
careful, detailed examination of the property — ^but as it is often
impracticable to make such an examination over an entire sys-
tem in such a short time that the wear neither increases nor
is removed during the examination, it is ordinarily more prac-
ticable and equally as accurate to determine this normal wear
as follows: —
For all parts which have been in use long enough to have
passed through an entire period or cycle of complete ^epail^-
determine the entire cost of one complete maintenance, i. e.,
the cost of a complete renewal of those parts subject to wear.
The amount to be deducted for normal wear is 50% of this
total maintenance cost, as the average condition of all the parts
is midway between the point of complete repair and of normal
disrepair. Whether or not this normal wear, which is inherent,
should be offset by a reserve account, is an undecided question;
but in examining a property the amount of this normal wear
should be determined.
F. Deferred MairUenance & Casualties: If proper and regu-
lar renewals have been neglected from any cause, the amount
of such deferred maintenance should be determined and this
amount deducted when arriving at Present Value. If the
buildings or equipment have been subjected to a fire, severe
Digitized by VjOOQ IC
§404] Physical Depreciation 361'
collision or other casualty, entailing a loss which is not charge-
able to regular maintenance, then the amount of such loss should
be determined and a proper reduction should be made. If a
reserve account is available to offset all or any losses, then the
amount of such funds will appear as a separate item to be added
to Present Value.
G.. The Remaininff Starvice Value is found by subtracting from
the Original Service Value the sum of ail the Depreciation
due to Obsolescence, Inadequacy, Age, Neglect and Casualties.
H. The PreeerU Value of the Physical Equipment is equal
to Remaining Service Value, plus Scrap Value.
§ 401. Depreciation rule contained in uniform water supply
accountSi 1911.
The Uniform Accounts for Systems of Water Supply
adopted in 1911 by a conference consisting of representa-
tives of the United States Bureau of the Census, American
Water Works Association, New En^nd Water Works
Associatidn, American Association of Public Accountants,
Ohio Bureau of Uniform Public Accounting and others
and published by United States Bureau of the Census,
contains the following in relation to depreciation (at
pagp27):
LoBses by depreeiaUon. — ^The losses of a corporation or mu-
nicipality (grating a water-supply system or other public
service utility enterprise are progressively increasing with the
passage of years for each structure, fixture, or appliance con-
stituting a part of its nonlanded and of some classes of its landed
permanent properties. Expressed in mathematical terms, it
is now a more or less accepted axiom of business management
that the losses from depreciation for any g^ven piece of property,
or of the water-supply system as a whole, through a number
of years constitute a geometrical series of which the loss of
each year is a small percentage greater than that for the pre-
ceding year, while the aggregate loss at the expiration of the
life of such piece of property, or system, is equal to its initial
cost, less its scrap value at the end of such useful life. The
Digitized by VjOOQ IC
362 Valuation [§ 404
line which would represent this progressive increase of loss is
sometimes called a "sinking-fmid curve," since it is used to
represent graphically the progressive increase in the assets of
a sinking fund whose resources are all kept invested at interest
and into which is annually paid a fixed sum, and all its interest
earnings are also added to the principal of the fund.
Depreciation is neither actually nor relatively the same for
any two establishments, even for the same industry. For this
reason it is impossible to frame concise general rules for making
allowances for depreciation which will not in their application
be attended with a large margin of possible error. To use such
rules without causing errors, those employing them must have
for each indi\adual establishment exact data based upon in-
spection, showing how far and in what respects its actual de-
preciation differs from that of the average establishment of its
class. For this reason a physical examination and appraisal of
waterworks should be made every 10 years, or even more fre-
quently, to provide the basis for an approximate estimate or
statement of the annual loss chargeable as an expense to de-
preciation. In the absence of such exact data for each water-
supply system, however, it is to be assumed that depreciation
takes place according to the average life of the several parts
of such system and of water-supply plants as a whole.
Until further study and experience or a series, of inspections
and appraisals at fixed intervals furnish more accurate data,
the average life of the various parts of the fixed properties of
a water-supply enterprise may be assumed to be approximately
as follows: For horses, carriages, automobiles, and laboratory
apparatus and appliances, 10 years; water meters, service pipes,
office furniture, and general operating equipment, 15 years;
boilers, steam pipes, and filtration equipment, 20 years; en-
gines, piunping machinery, and wood pipes, 25 years; masonry
of filtration plant, cribs, iron water pipes, intakes and connec-
tions, fire hydrants, standpipes, and buildings, 50 years; reser-
voirs, tunnels, and aqueducts, 100 years; and for the water-
supply system as a whole, 60 years. All these approximations
are subject to modification by reason of any unusual conditions
which may shorten or prolong the life estimated above. • . .
Digitized by VjOOQ iC
§405] Physical Depreciation 353
As outlined in these instructions for each and every part of the
system, it may be assumed that the current depreciation for
the system as a whole is approximately 2 per cent, of the origi-
nal cost of the system.
§ 406. Depredatioa of overhead charges.
In a majority of the recorded appraisals, overhead
charges have not been depreciated in estimates of repro-
duction-cost-less-depreciation. It has been assumed that
these elements do not depreciate with the structures.
This theory is stated in an article on the Appraisal of the
Seattle Telephone ^ Companies for the Raikoad Commis-
sion of Washington, by Henry L. Gray, Engineer to the
Commission. This is a valuation in a telephone rate case.
Mr. Gray says: •
The annual depreciation in dollars was derived by applying
the percentage of annual depreciation to the amounts estimated
as necessary to reproduce the different elements of the plant.
It should be noted that all indirect or loading charges, with the
exception of contingencies, were considered as non-depreciating.
It is admitted that such items as engineering, interest and
brokers' fees are as properly a part of the cost of the plant as
is the cost of poles, wire and cable, but the expense of the for-
mer items is practically all incurred during the construction
period. If the plant should be permitted to become entirely
worn out, then it would probably be necessary to again expend
money to satisfy these indirect charges, but as the plant is
maintained, and is earning money, it b fair to assume that the
sums invested in engineering, supervision and organization
expense, exchange right of way, interest during construction,
and brokers' fees remain intact as long as the plant is a going
conoemi and do not depreciate. In other words, depreciation
affects only property which wears out, which becomes obso-
lete or inadequate, and requires eventual replacement. As
indirect items do not require replacement, they do not depred-
t Engineering and Contracting, May 3, 1911, pp. S2Xhb2L
23
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364 Valuation [§ 405
ate. It is not contended for an instant that it is imnecessary
to expend money for such items after the plant becomes a
going concern. The items under discussion are only those
strictly chargeable to construction and not in any way con-
nected with maintenance. Hence in the calculation of the
annual depreciation in dollars, these indirect charges were
omitted, and they were also considered as having a value of
100 per cent, new in arriving at the depreciated value.
The uniform practice of the Wisconsin Railroad Commis-
sion in its public utility appraisals has been to depreciate
overhead charges with the depreciable property. This
rule was also followed in the Chicago street railway ap-
praisals. In the appraisals made by the New York Public
Service Conmiission for the First District interest and
taxes during construction and promotion expenses have
not been depreciated but all other overhead charges have
been depreciated with the depreciable property. The
Commission's attitude on this subject is expressed in
Re Metropolitan Street Railway Reorganization, 3 P. S.
C. 1st D. (N. Y.) 113, 155, decided February 27, 1911.
This case relates to capitalization after reorganization.
In rejecting the applicant's plan of estimating existing
depreciation, the Commission says:
The cost to be amortized does not include all items. General
contractor's profit, engineering, administration, etc., were
omitted. But if these items are properly included in cost-to-
reproduce-new, they should not be omitted from cost for amorti-
zation purposes. If they are not necessary to the original con-
struction of the property, they ought not to be included in
cost for any purpose; but the applicants did so include them.
It is clear that if they were charged to capital, and if the de-
preciation fund covers only net cost, then when replacements
are made and their cost taken out of the fund, there will be no
provision for overhead charges, and operating expenses will be
unduly depleted or capital account inflated by duplicate charges
Digitized by VjOOQ IC
§405] Physical Depreciation 358
for these items. It is also clear that when a power station wears
out or becomes obsolete or inadequate, the contractor's charges
for its construction, the money paid to engineers and architects,
etc., do not represent anything of value, but have disappeared
just as certainly as the physical parts themselves.
In general overhead charges depreciate, though not
necessarily in the same proportion as the phjrsical prop-
erties in the original creation of which they form a neces-
sary part. Many of these charges are of such a general
nature as to pertain not to any particular structure but to
the system as a whole. They do not have to be repeated
as the various parts and structures are replaced. Most
of them would have to be repeated in case the entire plant
or system should become obsolete. Possible total super-
session of this kind however is not taken into accoimt in
estimating existing depreciation.
Certain charges for engineering and supervision do
have to be repeated upon the replacement of the particu-
lar building or other structure and should therefore be
included in the depreciable value and depreciated in the
same degree as the structure itself. In so far as the con-
tingency item represents incomplete inventories it should
be subject to some depreciation, inasmuch as the unknown
articles andgStructures it represents probably depreciate.
This is true also of the allowance for accidents and losses
that are as likely to occur on reconstruction as for original
construction. In so far, however, as the contingency item
represents loss due to changes in plans during construction
and other losses that can not be avoided in original con-
struction, but which can be avoided in any reconstruction,
there should be no depreciation of the contingency item.
As to contractor's profit, it should doubtless be depre-
ciated, as, generally speaking, if a contractor's profit is a
proper element of cost on original construction it is also
a proper element on reconstruction. Interest during con-
Digitized by VjOOQ IC
356 Valuation [§ 405
struction is for the most part an element of expense that
will not have to be repeated except in case of a replace-
ment of the entire plant and is therefore not subject to
depreciation. In the case of buildings and other large
structures^ there will be an expense for interest during
reconstruction and to this extent the general charge for
interest during construction should be depreciated to
arrive at present value. Practically all items of organiza-
tion, promotion and development expense prior to the
beginning of construction are permanent and not de-
preciable. They do not have to be repeated on the re-
placement of the various parts and structures. Admin-
istration and l^al expense during the construction period
is an element that pertains chiefly to the entire plant and
does not have to be repeated in the replacement of the
particular parts.
Digitized by VjOOQ IC
CHAPTER XVIII
Cost-New V. Cost-Less-Depredation
§ 420. Statement of problem.
421. Importance of consideration that the entire initial capital can not be
ret^ned in the business.
422. Deduction of depreciation necessary to secure uniform investment
cost and uniform reasonable rate of charge.
423. Unamortized depredation.
424. United States Supreme Court considers depreciation reserve in-
vested in improvements, 1909.
425. Cost-of-reproduction-new approved — Massachusetts appraisal of
N. Y., N. H. & H. R. R., 1911.
426. Cost-of-reproduction-new approved — ^AppraisaJ of Chicago gas
plant, 1911.
427. Cost-of-reproduction-new approved — ^Wisconsin Railroad Commis-
sion.
428. Cost-of-reproduction-new approved — Columbus, Ohio, Electricity
Rate Case, 1906.
429. Cost-of-reproduction-new when depreciation is computed on sinking
fund plan — New Jersey Commission, 1911.
430. Deduction of existing depreciation necessitates allowance for annual
depreciation — United States Circuit Court, 1908.
431. Cost-of-reproduction-less-depreciation the approved rule.
432. Oklahoma Supreme Court in Telephone Rate Case, 1911.
433. Cost-of-reproduction-new rejected — ^New York Public Service Com-
mission, First District.
§ 420. Statement of problem.
A fundamental question is whether cost shall be di-
minished by an allowance for the existing depreciated
condition of the property in determining value for rate
purposes or pubUc purchase. Is cost-new or cost-less-
depreciation the most important factor in determining
value? In a valuation for purposes of purchase there is
little disagreement in holding that the depreciated condi-
tion of the property must be considered in fixing value.
Most such valuations have been based on cost-of-repro-
[357]
Digitized by VjOOQ IC
358 • Valuation [§421
duction-less-depreciation. In rate cases there is some
controversy over this point though the weight of authority
is unquestionably in favor of allowing for depreciation in
fixing the fair value for rate purposes.
§421. Importance of consideration that the entire initial
capital can not be retained in the business.
In the above discussion the annual allowance for phys-
ical depreciation has been referred to as something which
must necessarily be used at some future date to make good
such depreciation. This is the usual assumption but it is
only partly true. In every complex operating system
there must always exist a considerable percentage of
existing physical depreciation. A public utility plant
though continuously maintained in the best possible
operating condition will show continuously a considerable
percentage of depreciation. It has been stated that a
street railway maintained in good operating condition
will necessarily show a cost-less-depreciation of from 70%
to 85% of the cost-new. This follows from the fact that
renewals are being made continuously and at any given
time only a small percentage of the depreciable property
is in absolutely new condition. The depreciable property
therefore shows a depreciation all the way from nothing
up to 100% of the wearing value. It thus results that
the property as a whole will have a present value consider-
ably less than cost-new. This is a normal and inevitable
condition. A public utility plant does not and cannot
retain in the business the same investment in depreciable
property with which it starts. Recognizing this condition
it seems that the proper thing for the company to do
would be to promptly amortize a percentage of its initial
capital equal to the percentage which the cost-less-
depreciation of the property bears to the cost-new. This
early depreciation which takes place while the new plant
Digitized by VjOOQ IC
§422] Cost-New v. Cost-Less-Depbeciation 359
is settling down to a condition where it will show a normal
permanent depreciation of say 15% is a proper charge to
the earnings during this early period. But instead of
being placed in a depreciation fund or reserve where it can
never be used for the specific piupose intended, it should
be used to amortize the capital. This 15% is no longer
needed in the business. It is useless to impoimd it in a
permanent depreciation fund. The obvious thing is to
reduce the capital to the permanent requirements of the
business. This is perhaps never done in American prac-
tice, but what really amoimts to the same thing is often
done. The earnings which might be used to amortize this
portion of the capital are in fact used for betterments and
additions to the plant and thus the same result is reached
as if the earnings had actually been used to amortize
capital and new securities had been sold to cover the cost
of the betterments and additions. It seems clear there-
fore that this normal amount of permanent depreciation
should be deducted from cost-new in fixing fair value for
rate piuposes. It is also clear that the annual deductions
to meet this accruing normal amoimt of depreciation
should be paid in full and not as payments to a sinking
fund.
§422. Deduction of depreciation necessary to secure imi-
form investment cost and uniform reasonable rate of
charge.
There is another consideration that leads also to the
conclusion that existing depreciation should be deducted
in a valuation for rate piuposes. A public utility service
is assumed to be continuous. The service can only be
rendered by constructing plants, the parts of which will
inevitably deteriorate with age and use and have to be
reconstructed from time to time. There must always be
a start with a new plant and there will always exist a
Digitized by VjOOQ IC
360 Valuation [§ 422
certain percentage of deterioration in the old plant. As
the process is continuous the investment cost must be
assumed to be continuous. At first thought it might seem
that a uniform investment cost could only be secured by
assuming a uniform capital value. This would indeed
secure a uniform charge for interest and profits but not
a uniform total investment cost. The investment cost is
not simply interest and profits on the actual investment
in physical property but it includes all costs for repairs,
renewals and replacements necessary to keep such prop-
erty in good working order. Average annual expenditures
for repairs, renewals and replacements are greater in an
old street railway system than in a new system. In order
to equalize this increase in the investment cost there must
be a corresponding decrease in the annual charge for
interest and profits. In other words the investment must
be reduced. This is done with equity to the investor by
using the savings of the earlier years due to smaller ex-
penditures for repairs, renewals and replacements to
amortize the investment, i. e., to return to the investors a
portion of their original investment.
The fact that rates of charge are based on a fair return
on the depreciated value of the old plant does not mean
that rates will or can be reduced on account of 
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