the Accounting Department were analyzed, various annual reports were
examined and a corporate history of the road prepared.
Special forms for securing information were not prepared, and no rules,
or definite order of procedure to be used for all roads alike, were
adopted.
It is somewhat difficult to determine from the appraiser's report just
what part of it covers actual work done, and what part is theory
developed from the work, but presumably maps were prepared and profiles
secured which represented the original conditions of construction.
The field inspection was made on hand-cars or on foot, each field
inspector being furnished with the plans, profiles, etc.
The same conditions existed in Washington as elsewhere, that is, certain
records were not kept up, and were found to be inaccurate and
unreliable, and, as a result, the appraiser reported the condition to be
such as "to cause much unnecessary work subsequently in checking."
A percentage of depreciation was not placed in the field, but was
determined by "mortality tables," or by ascertaining the probable years
of structure life, then determining from the age of the particular
structure under consideration its percentage of depreciation, a method
by no means new. It is not stated that any attempt was made to compare
these tables with the rules of the Master Car Builders Association for
valuing equipment, and no field inspection of equipment was made. The
prevailing prices of materials formed the basis for estimating the cost
of reproduction.
The value of motive power and rolling stock was apportioned among the
States on the basis of engine- and car-mileage.
The land values were fixed by the Railroad Commission sitting as a
court; real estate men from the large cities, real estate experts
brought by the railway companies, and others testified; and, based on
this testimony, the value was determined by the Commission in the same
manner as in a condemnation case. Three right-of-way experts, all of
whom had had experience in purchasing right of way for roads, were in
the regular employ of the Commission, and details as to present values
were referred to them.
The chief point of difference between this work and that of the other
States apparently was the effort to ascertain first cost of the
properties plus additions. This was done by an examination of the
accounts of the railway companies.
The result of the Washington work, as far as rate-making is concerned,
is indeterminate, as the United States Courts have held that the
Commission may not fix freight rates. The Supreme Court of the State has
held that they could. The Supreme Court has also held that the Tax
Commission should accept the findings of the Railroad Commission for the
purpose of taxation, with the result, as stated by Mr. Gray, that more
than $1,250,000 more was received last year than during any prior year
from railroad taxes.
The report of the Washington appraiser differs widely from that for
other States in that it is diffuse and does not present the methods
clearly and systematically; it is difficult, indeed, to trace what was
actually done. The writer is loath to criticize, but this report is such
as to suggest comment on a number of points.
_1._—Throughout the report very great stress is laid on the cost of
making the appraisal. Such an undertaking as an appraisal of corporation
property should be done thoroughly or left alone. It matters not whether
the work of Professor Cooley or Professor Taylor cost $5 a mile or $50 a
mile, if a dependable result was secured. It does not appear to be good
taste either to criticize costs of work in other States, or compare the
costs in Wisconsin and Michigan with the costs in Washington.
_2._—A number of criticisms, amounting almost to reflections, are made
on the methods elsewhere. The appraiser says:
"Speaking for myself, I found the precedents established by Texas,
Michigan, and Wisconsin of little value either in deciding the methods
to be pursued in making the appraisals or in estimating the probable
cost of appraisal....
"In estimating present or depreciated values of structures, rolling
stock, etc., both Michigan and Wisconsin had sent experts into the field
to estimate the percentage of present value to each unit. In this manner
40,000 freight cars were inspected in Michigan and their 'present value'
estimated. To me this seemed to be not only a useless procedure but very
erroneous....
"The appraisals heretofore made in other states have been based almost
entirely upon field surveys and inspection, no attempt having been made
to secure the necessary data from the engineering and accounting records
of the railways. Why? The answer is found in the purpose of the
appraisal."
Such sentences, and others which, by inference if not by name, reflect
on work executed by men of high professional standing, are hardly in
good taste, even if true, in a report to a railroad commission of
another State. Whether or not he found little of value, the appraiser's
general line of procedure was not radically different from that followed
in Michigan and Wisconsin in getting all available data first from the
companies, then in making a field inspection before fixing values. If
misled by erroneous profiles, he went into an error needlessly, as it
was fully known in Michigan that records were in the condition described
before any field work was begun.
The inspection of freight cars in Michigan was not to "estimate present
value" but to determine at first hand whether the Master Car Builders
rules for valuation were safe to use, and to back up their use in Court.
The third paragraph quoted is a misstatement, due clearly to a
misapprehension of what really was done.
_3._—The spirit of suspicion of railroad men's motives is an unfortunate
one to carry into a railroad appraisal, much less into a report.
_4._—The writer fully realizes the magnitude of the task before the
appraiser who is asked to determine first cost plus improvements or
betterments.
Hardly a trunk line road exists to-day that has not grown up from a
small beginning, changed its line, reduced its grades, added safety
devices, changed the type of its bridges and buildings, increased the
weight of its rails, put in service much heavier equipment, in fact,
completely changed everything, except, perhaps, the original right of
way.
The task of securing from old accounting department records an accurate
statement of cost is—and the writer says it with the confidence born of
experience—an impossibility. It is a job of such magnitude as to be
practically prohibitive. The different systems of accounting, the
different policies of the management, as to charging betterments to
capital or operating expense, to say nothing of the countless errors
that creep into the distribution of accounts, place such an undertaking
among the labors of a modern Hercules, and, to one who has been engaged
even in the task of trying to ascertain what one year's accounting on a
large road may do in concealing betterments under the guise of operating
expense, it would appear that a result that could be sworn to as correct
was impossible of attainment along the lines suggested in this report.
The general question of the propriety of the use of mortality tables is
discussed elsewhere in this paper.
This document, as an addition to the literature of the subject of
valuation of properties, is disappointing, for if there were original
and valuable methods they are not explicitly described.
The cost of making the appraisal was about $13 per mile of line.
-----
Footnote 11:
_Engineering-Contracting._
THE VALUATION OF TRACTION PROPERTIES IN CHICAGO.
During 1906 a complete valuation of the property and franchises of the
surface roads of Chicago was made under the direction of a Commission
consisting of Bion J. Arnold, M. Am. Soc. C. E., and Messrs. Mortimer E.
Cooley, and A. B. du Pont. The report of this valuation was published in
the form of a pamphlet which is now practically out of print, as all
extra copies were long ago exhausted.
The instructions of this Commission from the Chicago City Council were:
"To consider the detailed inventories and estimates of value to be
submitted by the Street Railway Companies, to investigate the same and
to ascertain whether the values thus listed were reasonable, fair and
just."
Detailed inventories and estimates of value were submitted by the roads,
and, from time to time during the progress of the work, additions or
corrections to these schedules were made.
Reports showing income, operating expense, and traffic statistics were
made, and such detailed statements as were called for from time to time
were furnished.
The Commission organized its force for valuation work by using the
office and field organization of the Arnold Company under the direct
charge of George Weston, M. Am. Soc. C. E., for the major part of the
work, and retained Messrs. Theodore H. Hinchman, Jr., C. V. Conover, and
the writer to give special study to certain features of the appraisal.
In the determination of franchise values, Professor Henry C. Adams was
retained in consultation by the Commission.
In arriving at the value of the physical properties, a complete field
examination was made, depreciation determined, cost of reproduction
estimated, and in general, the work was carried on along lines quite
similar to those of the railway appraisals heretofore described in
detail.
Several very interesting and unique problems were presented, some of
which were as follows:
"Upon what basis shall the cable properties of the companies be
estimated—(_a_) as operating cable systems, or (_b_) as obsolete systems
having no value except so far as the physical property can be utilized
in the conversion of the cable lines into electric?"
In the final conclusions of the Commission, part of the cable lines were
treated in one way, and part in the other.
"What allowance, if any, shall be made for the pavements laid by the
companies on their right of way?"
The discussion of this topic, together with the opinions of counsel as
to the legal status, is of interest. The Commission did not consider the
value of paving as constituting any part of the physical property, the
value of which must be supported out of earnings. The present value of
the pavement was estimated and reported without specific recommendation
as to whether an allowance should be made.
The valuation of real estate was left in the hands of real estate
experts familiar with values in Chicago, each piece of property being
personally examined and valued, and the representatives of the roads
given such hearings as they desired.
In computing the value of physical properties, an allowance of 10% was
made to cover the following items:
"_1.—Legal Expenses_—including those incurred in securing 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 property goes into operation.
"_3.—Brokerage_—or the expense of securing the necessary moneys.
"_4.—Contingencies_—to cover incomplete inventories, unforeseen
difficulties of construction, and any and all other items of expense
which cannot be foreseen."
The only novel feature in this list is Item 3, which was not included
specifically in any of the railroad valuations made by States and
heretofore described.
The franchise and intangible property valuation, amounting to some
$9,000,000, or about one-fifth of the total, was a very important phase
of the work, and the Commission gave up a large part of the report to
its discussion.
The difficulties in this part of the work are described as threefold:
"_First._—The difficulty of determining what are the exact legal rights
of the companies in any given street or part of street, in absence of a
direct and final judicial decision as to these rights;
"_Second._—The difficulty in estimating the value of a line of street
railways, consisting of several parts, where each of these parts is
operated under a different tenure due to the character of the ordinances
or franchises, respectively; and
"_Third._—The difficulties arising from the absence of exact information
as to the receipts and expenditures on the several parts of a single
line covered by franchises of different length and character."
The Commission, having arrived at such an adjustment of the difficulties
as appeared just, determined the value of franchises in the following
manner:
It was assumed that the gross earnings on the different parts or routes
of each system were in proportion to the car-mileage.
The system was divided into routes, and the car-mileage was determined
for each route; then this information was compiled so as to show the
car-mileage, and consequently the gross earnings, apportionable to each
franchise.
The next step was to determine, in the same manner, the proportion of
operating expenses assignable to each franchise, the operating expense
being assumed to be uniform with gross earnings. A study of the
conditions in Chicago resulted in a determination upon 70% as a fair
proportion for operating expenses, taxes, and maintenance.
Next, the amount of capital investment to be supported out of earnings
was computed by estimating the cost of reproduction of track and
overhead lines under each franchise and apportioning the cost of land,
power-houses, barns, cars, tools, and stores in proportion to
car-mileage.
In determining earnings for the unexpired years of franchise life, it
was assumed that the earnings would increase in accordance with the law
laid down by Mr. Arnold in 1902.
The last step was to find the value of the net earnings of future years,
after deducting the sum required to support the invested capital. The
rate chosen was 5% compound interest. The sum of the different present
values thus found was the value of the franchise sought.
Two other points arising in connection with franchise values were:
"Where, on a street, franchises covering part of the street have
expired, and others remain in force, the contention of the city is that
the expired franchise is valueless because traffic under it can be
stopped; that of the company is that it still has value, as traffic can
be routed over other streets where franchises have not expired."
This was set aside on the ground that the value of any particular
portion of a street, or of a franchise, remains the same as long as the
system is considered as an entirety.
The second point was as to the value of traffic agreements; but this
complicated problem was also dismissed on the theory that when two
systems are considered as co-operating, the value of individual parts of
either system remains the same regardless of their ownership.
The values of their properties, fixed by the companies, included paving.
The total figures reached in this valuation were:
Companies' valuation, including paving, $73,555,675
Commission's " " " 50,994,782
Commission's " excluding " 46,652,747
This work affords many interesting problems, and is perhaps the largest
valuation for determining a price for the purchase of property that had
been made to date.
THE COMMERCIAL VALUATION OF RAILWAY OPERATING PROPERTY OF THE
DEPARTMENT OF COMMERCE AND LABOR.
In 1902 the permanent Census Office was established, and the Director
was authorized to collect statistics relative to public indebtedness,
valuation, taxation, and expenditures. The Bureau of the Census
co-operated with the Department of Commerce and Labor in the preparation
of the appraisal of the commercial valuation of railway properties of
the country.
The report of this work, issued as Bulletin 21 of the Bureau of the
Census, is the most interesting and valuable exposition of the subject
of railway valuations yet published, as it includes not only the report
of this particular work, together with the results, tabulated by States,
but appendices describing and discussing the work in States and foreign
countries, and the work of valuation by railway men.
The results are of prime interest, as they show the valuation of all
railway property in all the States, based on uniform methods of
appraisal and distribution, which enables a comparison to be made with
work done by the States.
The method adopted in this work was so radically different from that of
the various State appraisals as to make a detailed description a matter
of interest, and it is to be regretted that it cannot be included. The
method is really a capitalization of net earnings.
Owing to the nature of the inquiry, namely, to determine what part of
the wealth of the nation is devoted to railway transportation, it was
obligatory on the appraisers to adopt a method which would disclose as
nearly as possible the true market value.
Certain restrictions and limitations on the term, "value," and on the
use of the resultant figures of the appraisal, are suggested by
Professor Adams, as follows:
"The valuation submitted in this report may be properly defined as the
commercial value of property used by railways in connection with the
business of transportation. By 'commercial value' is meant the estimate
placed upon the worth of property regarded as a business proposition.
This must, of course, be the market estimate and not the arbitrary
estimate of a public official. The two fundamental considerations by
which the market is influenced in placing a value upon property when
bought or sold, are the expectation of income arising from the use of
the property, and the strategic significance of the property. These two
considerations are made the basis of the valuation of railway property
submitted in this report. The material made use of in this valuation is,
first, the operating and financial accounts of the railways; second,
inter-railway contracts and agreements; and, third, the published
records of the stock market.
"This is no place to enter upon a discussion of the nature and
classification of different kinds of value, but a word of caution may be
allowed in order to guard against an unwarranted use of the figures here
submitted. The commercial valuation of railway property, in so far as it
depends on income arising from the sale of transportation, is the
result, among other things, of an established schedule of freight and
passenger rates, from which it follows that such a valuation cannot be
used for determining the reasonableness or unreasonableness of the rates
in question. The solution of the rate problem demands a separate
valuation of the physical property.
"Again, in so far as the Government is precluded by its political
character from following commercial rules in the sale of any service
which it renders, a commercial valuation which assumes that property is
administered under the rules of private rather than public financiering,
might differ from the valuation of the same property regarded as a
public property. The purpose of this remark is to preclude a discussion
of the problem of the Government purchase of railways on the basis of
the values submitted in this report. It would of course be necessary to
modify these values by considerations of public utility, in order to
determine a public purchase price.
"Whether or not the commercial valuation here submitted can be used as
the basis of assessing railway properties for the purpose of taxation
depends entirely upon the taxing laws of the state for which the
question is asked. If these laws confine the appraisal of railway
property to its physical elements, the values here submitted would, in
the case of prosperous roads, exceed an appraisal for the purpose of
taxation. If, on the other hand, it is the purpose of the taxing law to
appraise railway property at its true cash value, unusual or abnormal
conditions being excluded, it may be that the commercial valuation of
operating property submitted in this report fairly measures its
appraisal for the purpose of taxation."
The methods are explained in the most minute detail by a series of
papers in the Bulletin.
The work of Professor Adams and his associates is of great practical
value in that it shows the discrepancy in the taxation laws of the
different States as relating to railroad properties, and in that it
gives a set of values determined by a uniform method, which, within
reasonable limits, furnishes a check on the work of the State
appraisals.
This method, of course, cannot be used for purposes of rate-making, or
of bond or stock restrictive legislation, but the general uniformity of
its results with those of State appraisals, and the radical differences
noted in the case of values for taxation in other States, lead very
properly to the inference that a value determined by this method is very
close to the truth.
THE EXTENT OF APPRAISAL PRACTICE.
There have been many appraisals of property besides those reviewed in
the foregoing pages. Several excellent contributions to valuation
literature, as a result of the numerous water-works appraisals, are
mentioned in the Appendix.
New Jersey and Nebraska have had railway appraisals in progress during
1909-10. At the time of writing, neither appraisal has gone far enough
to add any points of interest to the subject, except as the appraisers
in these two States discuss the subject and bring out new points.
Valuations of street railway property have been made in several cities,
Cleveland, Ohio, Detroit, and Milwaukee being the most recent.
The Cleveland and Milwaukee hearings have produced large records, and
have tended to determine finally certain principles of valuation.
Several valuations have also been made for corporations, among which may
be mentioned that of The Toledo Railways and Light Company, by Messrs.
Ford, Bacon, and Davis, and that for the New York, New Haven, and
Hartford Railway, under the direction of John F. Stevens, M. Am. Soc. C.
E.
This latter valuation offers some very interesting points, and, in view
of Mr. Stevens' standing as a railroad engineer, the adoption by him of
methods of inventory and field inspection would go far toward fixing a
precedent which would be acceptable to the railroads. It is to be
regretted that the interests of the road are such that it is not deemed
wise by its President to discuss even the principles of this work at
present.
In connection with the recent appraisal made by the City of Detroit, The
Detroit United Railway made an independent examination and appraisal of
its own property, with the double purpose of furnishing an inventory to
the city and of checking the work of the staff employed by the city.
This work for the railroad was done by officials and employees of the
company, under the personal direction of Mr. R. B. Rifenberick. It is
noteworthy for the completeness of its inventory, which goes into the
most minute detail, and for the excellence of the maps and drawings
which accompany it and show, not only every standard type of track,
rail, and all buildings and machinery, but every piece of track and
overhead special work on the entire system. This appraisal includes a
most complete and exhaustive study of average unit costs. Inasmuch as
this work is likely to be fully reviewed in the Courts in the near
future, any further description would hardly be proper. It is not too
much to say, however, that it probably stands as the most complete in
every detail, as to inventory and records, of all American appraisals up
to this date.
During the summer of 1910 the Railway Commission of Michigan ordered an
appraisal of certain large electric-power properties of the State. This
work was done by Professor Mortimer E. Cooley, assisted by Mr. Henry C.
Anderson and the writer. This appraisal, involving certain comparatively
new corporations, made it possible to obtain a fairly definite solution
of some of the problems relative to overhead charges.