Federal Courts. These cases have been examined, and such of the subject
matter has been quoted as would show the conclusions of the Courts as to
what constitute the various elements of true value. The latest Federal
decision bearing on the subject, and in many ways the most replete with
argument, is the case of Consolidated Gas Company _vs._ City of New York
(157 Fed., p. 849), which was decided in December, 1907.
In this case the valuation was determined by the master:
1.—A valuation of tangible assets, consisting of real estate,
plant, mains, services, meters and miscellaneous equipment,
and the property of subsidiary companies, the whole
aggregating $63,357,000. Of this an allowance of $3,616,000
was made by the master for working capital, and this entire
amount was treated as tangible property.
2.—Finally, an intangible value of 0,000,000 was assigned by him
to the franchise and good will.
Objections were raised, as follows:
(_A_) Land values represent no original investment by the
Company, do not indicate land especially appropriate for the
manufacture of gas, and increase the apparent assets without
increasing the earning power.
(_B_) The values of physical property are not original cost, but
are cost of reproduction less depreciation.
(_C_) Some of the property cost more than new articles of the
same kind at the time of inquiry. Some are of designs not
now favored by the scientific and manufacturing world.
The disputed questions involved, as far as tangible property is
concerned, were:
1.—Whether the values ascribed to the several enumerated items
are based on competent and persuasive evidence.
2.—Whether the method of valuation pursued by the master is in
accordance with law.
3.—Whether the items of property are "employed" (in the legal
signification of the word) in the production of gas.
The first, a question of fact, is found affirmatively, and the evidence
was found to be competent.
The second question is one of law, and, quoting from the cases cited in
this paper, the Court holds as follows:
"This method of valuation correct * * * 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.... 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 a 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
under the New York of 1907 is worth more than 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 expert estimates, or bookkeeping, inaccurate and perhaps
intentionally misleading. * * *
"The so-called money value of real or personal property is but a
conveniently short method of expressing present potential
usefulness, 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.
* * * It is not to be inferred that any American government intended
when granting a franchise, not only to regulate the business
transacted thereunder, and reasonably 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 private property 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 on 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. To 'working capital, Coke
and Coal Company, and Astoria' the above considerations are not
applicable, and these items will be treated separately."
The Court's review of the third question raises no points of special
interest as to valuation.
The question as to amount of "working capital" is taken up, and that
term is defined as:
"The amount of cash necessary for the safe and convenient
transaction of a business, having regard to the owner's ordinary
outstandings both payable and receivable, the ordinary 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 comparison can be drawn between
one business and another, or even between those of the same general
nature."
In this instance it is of interest to note that the Court reduced the
"working capital" from $3,616,000 to $1,616,000.
Perhaps the most novel and interesting part of this decision is that
dealing with the intangible elements of value. The master was unable to
separate the two elements, good will and franchise value, but gave their
combined value.
"From the testimony I think it apparent that what is here meant by
good will is the organization of complainant, long established, and
doubtless well manned and equipped. Such organization is clearly of
value, because without it neither tangible nor intangible property
can be profitably managed. Yet the organization itself is but a
method of utilizing that which is invested, it is really dependent
for its existence and continuance upon the franchise, without which
there can be no useful organization. Tangible property has a certain
value entirely apart from franchise or right to continue business,
but good will in the sense of the organization for the business of
furnishing gas, can have no existence whatever apart or detached
from the franchise conferring the necessary privilege. Would any one
think of capitalizing good will of this kind and distributing its
assumed value in the shape of new shares among stockholders new or
old? I think the most ingenious financier could not imagine such a
proceeding, and, if this good will be not property capable of such
capitalization and distribution, I do not think it property capable
of capitalization as against the State.
"Finally, this claim of good will seems to forget that for many
years the price and distribution of complainant's gas has been
regulated by law. A citizen is entitled to have a clean street
before his house because he pays taxes, _inter alia_, for that
purpose. He is much more plainly entitled to have complainant's gas
in his house because the company must give it to him if he pays for
it. I think it apparent that the conceivable good will of a gas
company in this city is about equal to that of the street-cleaning
department of the municipal government."
Is a public service corporation entitled to add the value of its
franchise to the assets from which a fair return may lawfully be
demanded? This question is taken up and discussed exhaustively by the
Court (157 Fed., 872 to 879), and while it is clear in reading his
judgment that he does not believe it sound doctrine to invest a
franchise with value, yet, after citing a large number of cases, he
reaches the conclusion that he is "compelled" to consider franchises,
not only as property, but as productive and inherently valuable
property, and to add their value, if ascertainable, to complainant's
capital account before declaring the rate of return.
This case went to the Supreme Court of the United States, where, under
the title Willcox _vs._ Consolidated Gas Company (212 U. S., 19),
citation is made to many cases in connection with the matter of
franchise value. The decision of the Court is:
"The value of real estate and plant is to a considerable extent a
matter of opinion, and the same may be said of personal estate when
not based upon the actual cost of material and construction.
Deterioration of the value of the plant, mains, and pipes is also to
some extent based upon opinion. All these matters make questions of
value somewhat uncertain."
The Supreme Court permitted the tangible values found by the lower Court
to stand. It concurred with the lower Court in that it was not a case
for a valuation of good will. It concurred with the lower Court in
holding that the company was entitled to the benefit of any increase in
tangible values, and that such increases should appear in the appraisal.
It did not agree with the Court in the increase of franchise value above
that which was capitalized in 1884, with the consent of the State of New
York, and reduced the franchise value figure to $7,781,000. On this
basis, the estimated return, under the new rate on the valuation of
$55,612,435, was 5½%, which rate, in view of all the circumstances, is
held to be not confiscatory and to be a not unreasonable return on the
investment. The franchise value, as commented on in these cases, is
referred to at considerable length in the following pages.
On January 4th, 1909, the case of Knoxville _vs._ Water Company (212 U.
S., 1) was decided. This, in some respects, is of greater value to the
engineer than any others cited, in its determination of methods. In this
the appraisement of the tangible property was made in minute detail, the
sum of $10,000 was added for "organization, promotion, etc.," and
$60,000 for "going concern."
"The latter sum we understand to be an expression of the added value
of the plant as a whole over the sum of the values of its component
parts, which is attached to it because it is in active and
successful operation and earning a return. We express no opinion as
to the propriety of these two items in the valuation of the plant
for the purpose for which it was valued in this case, but leave that
question to be considered when it necessarily arises. We assume
without deciding, that these items were properly added in this case.
This valuation was determined by the master by ascertaining what it
would cost to reproduce the existing plant as a new plant. The cost
of reproduction is one way of ascertaining the present value of a
plant like that of a water company, but that test would lead to
obviously incorrect results if the cost of reproduction is not
diminished by the depreciation which has come from age and use....
The cost of reproduction is not always a fair measure of the present
value of a plant which has been in use for many years. The items
composing the plant depreciate in value from year to year in a
varying degree. Some pieces of property, like real estate for
instance, depreciate not at all, and sometimes, on the other hand,
appreciate. But the reservoirs, the mains, the service pipes,
structures upon real estate, stand-pipes, pumps, boilers, meters,
tools, and appliances of every kind begin to depreciate with more or
less rapidity from the moment of their first use. It is not easy to
fix at any given time the amount of depreciation of a plant whose
component parts are of different ages with different expectations of
life. But it is clear that some substantial allowance for
depreciation ought to have been made in this case.
"The company's original case was based upon an elaborate analysis of
the cost of construction. To arrive at the present value of the
plant large deductions were made on account of the depreciation.
This depreciation was divided into complete depreciation and
incomplete depreciation. The complete depreciation represented that
part of the original plant which through destruction or obsolescence
had actually perished as useful property. The incomplete
depreciation represented the impairment in value of the parts of the
plant which remained in existence and were continued in use. It was
urgently contended that in fixing upon the value of the plant upon
which the company was entitled to earn a reasonable return, the
amounts of complete and incomplete depreciation should be added to
the present value of the surviving parts. The Court refused to
approve this method, and we think properly refused. A water plant
with all its additions begins to depreciate in value from the moment
of its use. Before coming to the question of profit at all the
company is entitled to earn a sufficient sum annually to provide not
only for current repairs but for making good the depreciation and
replacing the parts of the property when they come to the end of
their life. The company is not bound to see its property gradually
waste, without making provision out of earnings for its replacement.
It is entitled to see that from earnings the value of the property
invested is kept unimpaired, so that at the end of any given term of
years the original investment remains as it was at the beginning. It
is not only the right of the company to make such a provision but it
is its duty to its bond and stockholders, and, in the case of a
public service corporation at least, its plain duty to the public.
If a different course were pursued the only method of providing for
replacement of property which has ceased to be useful would be the
investment of new capital and the issue of new bonds or stock....
If, however, a company fails to perform this plain duty and to exact
sufficient returns to keep the investment unimpaired, whether this
is the result of unwarranted dividends upon over issues of
securities, or of omission to exact proper prices for the output,
the fault is its own. When, therefore, a public regulation of its
prices comes under question, the true value of the property then
employed for the purpose of earning a return cannot be enhanced by a
consideration of the errors of the management which have been
committed in the past."
The Court holds that there was error in only considering the operations
of the company for a period of one year, and that this should have
extended to enough time to remove danger of abnormal business conditions
and observe the effects of certain ordinances.
The decision of the Supreme Court, in the Omaha Water-Works case,
decided on May 31st, 1910 (_Supreme Court Reporter_, July 1st, 1910), is
of general interest in its discussion of the procedure of appraisers in
making a water-works appraisal, and in the distinction drawn between
appraisals and arbitrations; but it does not touch on appraisal methods
or elements of value, except to discuss "going values." The language of
Judge Lurton on this point is as follows:
"The option to purchase excluded any value on account of unexpired
franchise, but it did not limit the value to the bare bones of the
plant, its physical properties, such as its lands, its machinery,
its water-pipes or settling reservoirs, nor to what it would take to
reproduce each of its physical features. The value, in equity and
justice, must include whatever is contributed by the fact of the
connection of the items making a complete and operating plant.
"The difference between a dead plant and a live one is a real value,
and is independent of any franchise to go on, or any mere good will
as between such a plant and its customers. That kind of good will,
as suggested in Willcox _vs._ Consolidated Gas Company (212 U. S.,
19), is of little or no commercial value when the business is, as
here, a natural monopoly, with which the customer must deal, whether
he will or not. That there is a difference between even the cost of
duplication, less depreciation, of the elements making up the water
company plant and the commercial value of the business as a going
concern is evident. Such an allowance was upheld in National Water
Works Company _vs._ Kansas City (62 Fed., 853), where the opinion
was by Mr. Justice Brewer. [This decision is quoted in the foregoing
pages.] We can add nothing to the reasoning of the learned Justice,
and shall not try to. That case has been approved and followed in
Gloucester Water Supply Company _vs._ Gloucester (179 Mass., 365,
and 60 N. E., 977), and Norwich Gas and Electric Company _vs._
Norwich (76 Conn., 565). No such question was considered in
Knoxville Water Company (212 U. S., 1) or in Willcox _vs._
Consolidated Gas Company (212 U. S., 19). Both cases were rate cases
and did not concern the ascertainment of value under contracts of
sale."
The writer does not read into the language of this decision an approval
of a separate element of value to be called "going concern value" or
"going value" in addition to other non-physical values, but rather a
recognition of the fact that certain non-physical elements of value, by
whatever name they may be called, must be taken into account in arriving
at the fair and equitable final figure of value of a live and operating
concern for the purpose of carrying out a contract of sale.
It appears to be doubtful whether the Court can be construed as
approving such an element of value in rate cases.
It thus appears that the United States Courts have laid down a few
rules, which may be regarded as fixed and definite and must be followed,
but that many important questions have not yet been decided. The value
to be determined must be a "fair value" of the property being used for
the convenience of the public. The par value of stocks and bonds may not
alone be considered (although it may be considered), the market value of
stocks and bonds, original cost plus cost of additions, the probable
earning capacity, the cost of reproduction, depreciation, appreciation,
all these, and any others that will throw light on the "fair value" must
be taken into account and given the weight to which they are entitled.
Any fictitious book values due to over-issues of stock and bonds are to
be given no weight, but the appraisal must give the fair value, in the
light of all the facts, of the property in actual use at the time of the
appraisal.
There are several decisions of the State Supreme Courts which discuss
these subjects, but an examination of a number of these gives
practically nothing more, in the way of definite conclusions as to
method, than has been cited. Perhaps the most complete and painstaking
consideration of appraisal problems by any Court was that given by Judge
Savage of the Supreme Court of Maine (97 Maine, 185, and 99 Maine, 371).
These were neither rate cases nor taxation cases, but proceedings under
statute to require from the Court instructions to a board of appraisers
appointed to value the plants. In the later or Brunswick case, Judge
Savage elucidates a number of points left not altogether clear in the
Waterville case. The Brunswick decision contains some interesting views
on "going value," and the Court's remarks on the general difficulties in
making rules for an appraisement are exactly to the point:
"There are many difficulties, if not dangers, in attempting to
formulate rules which are to be applied to facts not yet
ascertained. While it may be easy enough to state rules in the
abstract, it is much more satisfactory in an opinion of the court,
to express them in terms which are applicable to the facts in the
precise case in hand.... It must be always understood that our
answers to these questions are intended to be given only in the most
general and comprehensive terms, which may, or may not, be found to
be fitted to the facts which may subsequently be developed. No other
course would be wise or safe.... A public service property may or
may not have a value independent of the amount of rates, which for
the time being may be changed. A public service company may, under
some circumstances, be required to perform its services at rates
prohibitive of a fair return to its stockholders, considering their
property as an investment merely....
"Now, what is the property which the district has taken by power of
eminent domain? In the first place it is a structure, pure and
simple, consisting of pipes, pumps, engines, land rights, and water
rights. As a structure, it has value independent of any use, or
right to use, where it is, a value probably much less than it cost,
unless it can be used where it is, that is, unless there is a right
to use it. Nevertheless, it has value as a structure. But, more than
this, it is a structure in actual use, a use remunerative to some
extent. It has customers, it is actually engaged in business, it is
a going concern. The value of the structure is enhanced by the fact
that it is used in, and in fact is essential to, a going concern
business. We speak sometimes of a going concern value as if it is,
or could be, separate and distinct from structure value—so much for
structure and so much for going concern. But this is not an accurate
statement. The going concern part of it has no existence except as a
characteristic of the structure. If no structure, no going concern.
If a structure in use, it is a structure whose value is affected by
the fact that it is in use. There is only one value. It is the value
of the structure as being used. That is all there is of it."
The Court then argues that, as the structure is being used under
authority and by virtue of franchises, it is more valuable. The
franchise, however, is limited; other and competing franchises may be
granted; a franchise may exist entirely independent of a structure. He
holds that the structure is more valuable with the franchise.
"It is a structure in actual use, and with a right on the part of
the owner to use it and to charge reasonable rates to customers for
services rendered. It is threefold in discussion but it is single in
substance."
This case is largely taken up with a discussion of the reasonableness of
rates which furnish a basis for the estimate of value. There is no
specific attempt to describe methods of procedure. That is left to the
appraisers. These two Maine Cases, together with a valuable paper[17]
thereon by Leonard Metcalf, M. Am. Soc. C. E., constitute an extremely
valuable addition to the literature of appraisements.
It is clear, from a study of all the cases referred to in this paper,
that the Courts have laid down a line of precedent which is equitable
and just, that the interests of both public and corporations will be
safeguarded, and that the likelihood of any unfair or improper
valuations passing the scrutiny of the Supreme Court is but remote.
-----
Footnote 17:
_Transactions_, Am. Soc. C. E., Vol. LXIV, p. 1.
PHYSICAL VALUES AND METHODS FOR THEIR DETERMINATION.
All the foregoing narrative of methods adopted in recent valuations,
review of judicial opinions, and comment on the expressed opinions of
various engineers and railway officials, is presented as being proper
and necessary to support the contention that the Michigan valuation,
while not the first appraisal work, was the first valuation work of
large magnitude undertaken by any State; that it was a work which
established many precedents; and that the complete discussion of methods
and principles in connection with and following this appraisal has given
it probably a greater general value than any similar undertaking. The
Wisconsin work, which immediately followed that of Michigan, was along
lines similar to those of the Michigan physical valuation, and carried
the work forward, adding to and strengthening certain of its features.
Without any impropriety, it may be claimed that these two appraisals
have laid down the general lines on which this class of engineering
effort will be largely directed in the future.
It is desirable, in closing this paper, to indicate such general methods
of procedure in valuation practice as may be said to have been
thoroughly established by precedent, and to present such argument as
will support the contention that such methods are proper.