subject, that problems of this class are not capable of exact
mathematical solution; that, no matter how much care may be exercised in
the execution of the work, the result is tempered by the personal
judgment of the men engaged on it, and that only when it is executed by
men of experience, sound judgment, and high moral worth can it have a
definite, final, and just result.
This feature of appraisal work cannot be too strongly emphasized. The
value of the work depends on the character of the men doing it, their
experience in design, construction, and operation of properties, and
their absolute fairness and freedom from prejudice.
That there will be many large valuations undertaken in the near future,
there appears to be no doubt. These valuations will be made as a
necessary preliminary to three classes of corporate control:
rate-making, taxation, and the regulation of capitalization.
The Courts hold that the value must be "the fair value of the property
used for the public," and that the corporation:
"may not impose upon the public the burden of such increased rates
as may be required for the purpose of realizing profits upon [such]
excessive valuation or fictitious capitalization." (Smyth _vs._
Ames.)
This language is repeated, again and again, so that it is clear that any
valuation, to be sustained by the Courts, should:
_1._—Be based on a careful study and analysis of all the information
applicable to the case in hand; and
_2._—That it must separate the various elements so that every step of
the work may be reviewed and supported.
Public interest demands that, in any valuation, certain figures shall
appear which shall show the amount of _bona fide_ capital actually
existing in the property at the date of appraisal.
The fact that a given amount of money was invested in building a
railroad in 1880, and that certain other sums were spent for additions
in subsequent years, does not necessarily indicate that these amounts of
capital will still be found in the property in 1910.
The removal of timber from surrounding lands, the destruction of
industries and the removal of tracks leading thereto, the destruction of
equipment and facilities, the depreciation in value of adjacent
property, along with wear and tear, and obsolescence, have gone to
effect the destruction or loss of capital on many Michigan railroads.
The case in 212 U. S., 1, clearly directs that the valuation must not
take into account this destroyed capital, but must return a "fair value
of the property as it is."
On the other hand, the amount of money actually spent in producing a
given property in the past may be far below the present value. The
appreciation of value of lands by reason of development of cities and
growth of industries, the increase in cost of the materials entering its
construction, and many other causes, may lead to an appreciation of the
value of the property, and this appreciation should appear in the
valuation and the company be entitled to the benefit of it. It is in the
nature of an increase of the investment, and should appear as capital.
It is clear that there are two classes of elements of value in the final
value of a public service property: those which are physical, and those
which are intangible. There are various of the physical elements of
value which are not material or susceptible of inventory, but which,
nevertheless, attach themselves to the physical property, are capable of
determination, within reasonable limits of certainty, and should be
taken into account and computed as physical property.
In the subsequent discussion of physical and intangible values, it is
attempted to differentiate between such elements as should attach to the
physical value, or capital remaining in the plant, and the purely
intangible or franchise values.
It is contended by the writer:
That the Physical Value, or present value of the physical property,
should fairly represent the actual capital invested in the property at
the date of appraisal; that it should be made up of the sum of the
various elements which constitute the cost of reproducing the property
together with any appreciation which may have been added to any of them,
less all depreciation.
That the Non-Physical Value is the difference between the "fair value"
as defined by the Courts, or the reasonable value of the property as a
business or producing property, and the physical value, or actual
present worth; and that the only proper method for determining such
values involves a study of income accounts.
This Non-Physical Value may be: positive, or a value in excess of the
physical property, or negative, or less than the physical value. In the
case of a property having a negative intangible value, a deduction
should be made from the physical value.
It is further contended that, in making the physical appraisal, the
purpose of the appraisal should not be permitted to modify the figures.
The resultant figure should be the same, whether it is to be used as a
basis for assessment, rate-making, or limitation of capitalization. It
should be an engineering estimate of the amount of _bona fide_ capital
still remaining in the property, or of the complete cost of reproduction
under existing conditions, less depreciation. This figure is definite,
within reasonable limits, and it cannot be conceded that it is
permissible to vary it, submitting one result as a physical value for
taxation, and another and different result as a present physical
valuation for rate-making.
There may be some question as to the propriety of using non-physical
values for certain ultimate ends; in fact, the Supreme Court, in the
Omaha and Knoxville water cases, clearly indicates that they must not be
used for certain purposes; but, in any case, to furnish information,
this element of value should be determined, and, as in the case of
physical values, it should be an unchangeable figure[18] and should
represent the difference between the worth of the actual physical
property and the final business value of the property considered as an
earning proposition.
It is not necessary to go minutely into detail as to the various steps
to be taken in making the appraisal of physical property. Each appraisal
will offer some problems peculiar to itself, and no general set of rules
can be laid down which will be applicable to all cases. It is deemed
sufficient to call attention to general matters of major importance and
to refer to some points which have not been mentioned in the preceding
narrative, omitting argument in the case of such as have there been
fully discussed.
The distinction should be kept in mind that any element of value which
belongs to the property by reason of its physical existence is classed
as an element of physical value. The property is considered as an
operating property in the sense that it is reproduced complete, ready to
operate; and any expense, or any element of value needed to complete it,
is an element of the physical value, but any value arising as a result
of surplus earning power, any good-will value, going-concern value, or
value due to established business, strategic location, favorable traffic
arrangements, etc., should be considered as intangible values.
The valuation of physical property is naturally divided into four parts:
I. —The preliminary study,
II. —The field inspection,
III. —The computation,
IV. —The preparation of the final figure.
I.—The Preliminary Study.
The preliminary steps should include a general examination of the
property, a study of its corporate history, an examination of its
records, maps and profiles, and the preparation of an inventory of its
property.
The work in Wisconsin and Minnesota was done in co-operation with the
railroad companies, who prepared (generally, but not in every case)
their own inventories on forms adopted by the appraiser. In Michigan,
all this information was secured by the appraiser. There can certainly
be no valid objection to the use of information compiled by the
companies, whose familiarity with their own records and property would
enable them to supply lists which under all ordinary conditions would be
more complete and up-to-date than if made up by men having no special
knowledge of the property.
The chief difficulty encountered in making an inventory from recorded
data lies in the fact that very few sets of records are corrected to
date, and many additions and erasures will of necessity have to be made
in the field.
In making a field inspection, it is of great assistance to be able to
refer to maps of large yards, to profiles, to standard plans, and to
drawings of the principal structures, so that the investigation of
office records should include a careful examination of the maps of
principal terminals, with a view to securing such as will simplify the
field inspection. The investigation should be extended to cover a study,
not only of the engineering office data, but also statistical data to be
derived from the records of the auditor, superintendent, and
superintendent of motive power, and should cover earnings, operating
expenses, car and locomotive mileage, and such other data as will
facilitate the distribution of such elements of value as are not
localized, together with such other statistics as will furnish a
thorough knowledge of the property and its operations.
It has been claimed by the appraiser in Washington—and the view is also
held by the Commissioner of Railroads in Nebraska—that original cost is
essential, in view of the Supreme Court's decision, particularly in
Smyth _vs._ Ames. The writer cannot accept the correctness of this
position. It would appear that the language of the Court should be
construed to mean that original cost, where ascertainable, is a proper
matter to take into account, along with many other things; but it can
hardly be considered mandatory.
In the case of a property only recently built, in which the records are
complete and the engineering and construction files are available, it
may not be specially difficult to determine cost, but in the case of any
of the large railway systems of the United States, which are made up of
the consolidation of many different roads, some of them built many years
ago, some of them having gone through many changes of management,
reorganization, and earlier consolidation, it is practically impossible
to secure either the old financial books or the old construction
records, and without these complete records it would appear to be an
utter impossibility to secure the primary cost. Primary cost is but the
first step. The work of building up, by securing the amount of additions
and betterments that have been made from year to year, is one of
appalling magnitude and of utter uncertainty and conjecture. Keeping in
mind that, prior to July 1st, 1907, the railroad companies of the
country did not have a system of uniform accounting, and that additions
to property were charged to operating expenses to the extent of hundreds
of millions of dollars; that policies were different on different roads,
and under different managements of the same road, and that the
accounting methods were determined by the policy of the road or
management; and the further fact that the distribution of ordinary
railroad accounts may be extremely reliable on one road and abounding
with errors on another; it will be seen that any attempt to depend on
the auditor's office for anything approximating a complete statement of
cost would lead into a maze of figures which would be confusing,
unreliable, and incapable of proof.
Therefore, it is the writer's conclusion that, beyond such figures on
recent construction, or records of cost of such special structures as
are matters of particular record, it is not advisable to attempt to
secure complete data as to the cost to date of a railroad. In the
Michigan appraisal, original cost was secured in the case of many
structures, notably the Port Huron Tunnel, and it is by no means argued
that original cost should not be considered, or investigated, but it is
held that such an undertaking as to secure, from the financial books of
the company, an accurate or reliable statement of construction cost,
plus additions and betterments, less property destroyed, of the Michigan
Central Railroad, for example, would be absolutely an impossibility,
particularly if the work was to be undertaken, as in the Washington
appraisal, by men who were utter strangers to the property. The
admission of the appraiser of Washington, that, except for a few gaps,
the information was complete, is fatal, as the gaps must needs be filled
by estimates, and it would appear to be better to depend on estimated
figures throughout than to use what purported to be actual costs on part
and estimates on the remainder.
If original cost is essential, it is hard to get away from accepting the
book values of the companies, as these, objectionable as they may be,
from the viewpoint of the public, are just as apt to be as near the
actual truth as any statement made up by strangers from an examination
of old records covering many years of operation.
II.—The Field Inspection.
The field inspection, to be of the greatest value, should be made by
civil or mechanical engineers of long experience, preferably by men who
have had charge of their respective departments on railroads of
considerable extent, or of properties similar to that under
investigation. The writer is of the opinion that in this particular
phase of the work, the practice adopted in the Michigan appraisal was
considerably in advance of more recent valuations. Each particular
structure or piece of equipment should be examined and its condition
noted; special features should be fully described and careful record
made of everything that would tend to affect the value. The argument has
been often made that the fixing of a percentage of depreciation by a man
in the field is purely arbitrary and amounts to nothing but a guess. In
the computing office it is often necessary to check the field figure of
depreciation by the use of tables of fixed annual depreciation, but it
must be borne in mind that mortality tables of any form are based on a
system of averages. The actual depreciation on rail, for instance,
varies greatly; the conditions of traffic, curvature, gradient, rolling
stock, and various local conditions tend to shorten or lengthen the
life, so that the personal opinion of an experienced man on the ground
is likely to be much more nearly correct than the arbitrary application
of a rule of averages.
The writer has inspected station buildings more than 50 years old, and
their condition and adaptability for the service required of them would
give them a very high percentage; he is also familiar with buildings
less than 10 years old, which, by reason of changed traffic conditions
and consequent shifting of business, have become obsolete and have been
permitted to depreciate so rapidly that any table average would give too
high a result.
In the case of a water-works inspection, so much of the value is
included in the system of distribution mains, a form of property which
is inaccessible, that much more dependence must be placed on a figure
based on age; but there, also, as full investigation as possible should
be made, in order to determine to what extent tuberculation or
electrolysis has affected the pipes.
A general inspection (made in Minnesota by the appraiser with two
assistants) would appear to be an excellent thing as a review of the
whole work, but whether such an inspection would be sufficiently
thorough to base thereon a set of final values, would appear to be
doubtful.
The inspection in the field, in addition to the placing of a percentage
for depreciation, should involve a complete check of the inventory, a
correction of all errors, due to the construction of new property or the
destruction or removal of old, and a compilation of all information
required for a complete, correct, and intelligent appraisal of the
physical property by the computing office. Every appraisal is different,
and every property offers new problems and diverse conditions. These
must be met, and therefore the field inspector must call particular
attention to all matters specially affecting the values of the property
he is inspecting.
It is impossible to anticipate all these conditions in advance, although
the use of carefully prepared blanks and the standardizing of the form
in which the data are gathered greatly simplify the work, not only in
the office, but in the field.
III. The Computation.
On the completion of the field work, with all the preliminary data in
the office, the computation must proceed, and with this part of the work
there are many questions which must be taken up, considered, and
definitely answered.
The classification and arrangement of the information as to the property
to be valued, the costs and prices of the various materials entering
into construction, the making and checking of such tables as may be
required for estimating, the computing, checking, filing, indexing, and
the various other routine details of work need not be referred to
specially, as they must be worked out for each appraisal. The matters of
principle that will be met are more important, and, while it would be
impossible to mention all that may come up, it may not be amiss to refer
to a few.
(_a_) In making an appraisal of several properties, to what extent shall
these properties be grouped or classified?
(_b_) What unit prices shall be assigned in the estimates of cost of
reproduction, and how shall they be determined?
(_c_) How shall right-of-way and real estate values be ascertained?
Shall such elements as appreciation, or any increments due to the
purpose for which the land is used, be treated as physical or
non-physical values?
(_d_) What method shall be finally adopted in determining depreciation?
What elements shall depreciation be made to cover?
(_e_) What elements of cost or appreciation shall be treated as parts of
the physical property although not capable of inventory, and what shall
be treated as non-physical?
(_f_) Is an allowance for contingencies a proper item to include in an
appraisal?
(_g_) What weight shall be given the matters of adaptability, proper or
improper design, and the economics of location?
(_h_) How shall the values of such property as locomotives, cars, etc.,
be geographically assigned?
(_i_) What is the effect upon values of large terminals?
(_j_) Should an allowance be made by reason of rapid development of the
art?
These are not by any means all the perplexing questions that arise; each
valuation offers some that are special, but these cover the more
important points.
(_a_) _Classification of Properties._—In making an appraisal involving
the properties of a large number of companies, such for instance as any
of the State railroad appraisals, it becomes evident that there are
certain properties which are small, badly run down, and either built to
serve a very limited trade or located in a territory which has not
developed, and that such properties cannot be compared equitably with
the large trunk-line roads, or even with smaller roads in a good
territory and doing a good business. Several such properties exist in
Michigan in a district which was originally a lumber-producing country,
and at the time they were built local conditions were such that prices
of timber and labor were far below any cost that it would be reasonable
to assume to-day. Whether taxation or rate-making be the ultimate end of
the work, it is certain that these carriers are entitled to some
classification which will separate them from the more prosperous roads.
Many of these roads would not be built to-day under any circumstances,
yet their maintenance and continued operation is absolutely essential to
the people of the district served by them.
Whether this classification should be undertaken at the time of making
the appraisal of physical property, and an attempt be made to classify
unit prices, or whether this should be taken up in connection with the
intangible values, and solved, as far as the valuation is concerned, by
the adoption of such a method as will affect these physical values by a
subtractive or negative non-physical value, or whether the entire matter
should be left for the subsequent work of rate-making or assessment, is
one which must be determined at the outset of the physical valuation. It
may not be left without determination, as the question will be raised in
all probability in the form of an attack on the valuation, if it is not
considered and a conclusion reached.
It is the writer's opinion that the application of an intangible
subtractive value is the proper solution, except in the case of roads
which would not to-day be rebuilt. In fixing a uniform price for
identically the same labor or material, whether on a small
poverty-stricken road or a main trunk line, no serious injustice is
done, provided the price fixed is one which, from a strictly engineering
standpoint, is a reasonable figure for cost of reproduction. The
differences in class are due, not to special differences in cost of
physical property, but rather to differences in earning ability on
account of good or poor territory served, efficient or inefficient
management, or other reasons not connected with the physical structure;
hence such differences are reflected in the earnings, and are clearly
elements to be adjusted in the non-physical valuation.
(_b_) _Unit Values._—The general reliability of the appraisal rests very
largely on the reasonableness and fairness of the various prices which
are applied to the different parts of the property in making the
estimate of cost of reproduction. These unit prices should be determined
before any actual figures are made. They should be made up from the most
complete data available, and, before being tabulated, should be
carefully reviewed by all the experienced men engaged on the appraisal,
in order that no figure which is either too high or too low may be used.
As a basis, the average of either 5 or 10 years should be used in
preference to current prices on all such material and equipment as is
fairly stable. Rail, and all forms of rail structures, machinery,
locomotives, cars, etc., can be reduced to such a unit that averages can
be secured which will eliminate the error due to a period of extreme
high or low prices.
In the case of such materials as lumber and ties, the price of which has
been steadily rising, due to the growing scarcity of the material, a
price based upon a long average is unfair to the corporation, and it
would appear to be proper to use current prices. There can be no
hard-and-fast rule which will be applicable to all appraisals. The unit
prices must be such reasonable figures as can be sustained in Court.
Their adoption should not be final until every possible test of their
accuracy and reasonableness has been made. When they have been adopted,
and such modification made as may be fair for certain territory, on
account of local conditions, transportation facilities, or other
consideration which may affect them, the adopted figures should be
applied to all property alike. The use of different unit figures for
different roads in the same territory is highly undesirable, and should
be avoided.
(_c_) _Right of Way and Real Estate._—The valuation work which has been
accomplished during the past decade, and the study of values for
taxation and rate-making, have brought into prominence the perplexing
features of land values as applied to corporation property. It is
comparatively simple to fix within very close limits the reproduction
cost of tracks, bridges, locomotives, or any of the other elements of
physical structure. Not so with the land. A few years' development may
change farm land right of way into city right of way, surrounded by
factories, or it may change desirable residential property adjacent to a
road into slums.