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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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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examined  but  the  unpublished  reports  of  special  masters 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. 

[vii] 


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§  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, 

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§  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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Tablb  op  Contbntb  xi 

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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xii  Table  of  Contents 

§  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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Table  op  Contents  xiii 

§  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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§  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 


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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 


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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]& 


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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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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. 


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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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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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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. 


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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. 


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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. 


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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 


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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. 


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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 


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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. 


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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. 


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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 


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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. 


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§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 


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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 


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§  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. 


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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. 


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§  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. 


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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. 


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§  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 


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§  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 


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§  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 


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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 


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§  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) : 


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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. 


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§  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. 


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§  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- 


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§  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 


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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 


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§  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- 


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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- 


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§  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. 


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§  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 


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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 


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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 


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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- 


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§  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 


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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. 


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§  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. 


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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 


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§  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 


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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 


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§  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 


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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 


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§  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 


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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 


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§  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 


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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. 


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§  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 


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^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 


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§  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 


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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 


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§  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 


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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 — 


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'§  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* 


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*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 


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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] 


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§  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. 


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$  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. 


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§  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 


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§  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- 


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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 


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§  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): 


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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. 


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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. 


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§  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. 


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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 


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§  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 


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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] 


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§  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 


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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, 


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§  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 


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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. 


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§  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- 


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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 


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§  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. 


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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 


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§  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 


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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. 


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§  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: 


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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 


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§  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 


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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- 


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§  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 


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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. 


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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 


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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 


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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. 


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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] 


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§  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 


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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. 


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§  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- 


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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 


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§  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 


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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. 


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( 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 


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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 


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§  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). 


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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 


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§  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 


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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. 


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§  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. 


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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 


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§  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 


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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 


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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 


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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 


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§  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, 


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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 


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§  ^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. 


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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 


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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 


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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 


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§  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. 


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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* 


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§  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 


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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. 


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§  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. 


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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. 


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§  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 


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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. 


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$  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. 


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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 


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§  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 


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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. 


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§  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 


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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- 


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§  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 


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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, 


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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. 


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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. 


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§  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 


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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. 


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§  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. 


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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 


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§  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 


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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, 


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§  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. 


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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 


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§  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. 


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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 


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§  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. 


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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. 


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§  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.  .  .  . 


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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 


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§  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- 


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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. 


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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] 


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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. 


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{ 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- 


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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. 


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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» 


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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. 


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$   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). 


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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. 


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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. 


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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. 


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§  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- 


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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- 


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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 


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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). 


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§  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.) 


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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] 


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§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 


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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 


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(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 


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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 


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§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. 


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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 


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§  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 


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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 


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§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? 


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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. 


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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- 


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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: 


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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. 


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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 


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§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- 


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$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. 


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§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. 


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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. 


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/ 

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. 


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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. 


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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] 


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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 


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$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- 


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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.  .  •  • 


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§  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. 


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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 


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§  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 


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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. 


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§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. 


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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" 


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{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. 


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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. 


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$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. 


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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: 


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$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. 


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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. 


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§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 


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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. 


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{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* 


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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. 


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§  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. 


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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- 


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§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 


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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. 


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§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. 


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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^ 


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§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. 


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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. 


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§  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. 


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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. 


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§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. 


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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. 


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§  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 


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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. 


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§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. 


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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 


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§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. 


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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 


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§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 


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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, 


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§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 


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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 


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§  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- 


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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. 


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§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 


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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 


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§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. 


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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. 


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§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 


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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 


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§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- 


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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. 


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§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. 


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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. 


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§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, 


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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. 


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§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. 


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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 


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§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. 


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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] 


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§  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 


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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* 


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§  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. 


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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 


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§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 


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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- 


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§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- 


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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. 


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§  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 


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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 


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§  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 


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'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. 


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§  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- 


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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 


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§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 


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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. 


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§  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. 


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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. 


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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 


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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 


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§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 


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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. 


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§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 


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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 


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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 


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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. 


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§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. 


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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. 


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§  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 


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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 


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§  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. 


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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. 


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§  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. 


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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- 


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§  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 


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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 


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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 


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§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 


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§  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. 


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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. 


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§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 


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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. 


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§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 


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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. 


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§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 


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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 


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§  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 


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"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 


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§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 


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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 


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§  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. 


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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 


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§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 


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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. 


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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] 


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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 


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§  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. 


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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 


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§  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 


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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 


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§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, 


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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 


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§  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 


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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' 


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§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 


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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 


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§  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. 


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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. 


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§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 


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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 


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§  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 


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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 


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§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- 


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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. 


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§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 


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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 


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§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 


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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.  •  .  . 


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§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 


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§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- 


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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. 


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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] 


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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 


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§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 


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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