regulation, taxation, and authority to restrict indebtedness, and also
prescribe that it should appraise the value of the property of the
railroads, and use that appraisal as the basis for its acts. Would it be
logical for that board to make and apply one system of valuation for one
purpose and another system for another purpose? Manifestly, it would
have declared that a valuation was a "valuation" for all purposes, at
least as far as the physical property was concerned; and, when devising
a method for making its appraisals, it should incorporate therein all
the elements of value which might apply logically to either purpose. The
writer believes that "depreciation" of roadbed and structures would have
no place in such an appraisal, on the one hand, nor its negative, but
fully as intangible and difficult of concrete estimate, "adaptation and
solidification of roadbed," on the other.
It should not be understood that the writer maintains that taxation
boards should not go beyond the valuation of physical property to arrive
at a final basis for assessment. There are certain intangible elements
which should be taken into consideration when taxing property, chief of
which is the net income. It is only as far as physical valuations apply
in either case that he considers that there should be uniformity.
He does not approve at all of incorporating in an estimate of the
physical value of a railroad property such an element as "adaptation and
solidification of roadbed," which is credited with so much importance in
the Minnesota valuation. In the first place, such an element is
incapable of being measured in tangible terms and reduced to a
dollars-and-cents basis; second, it cannot be reproduced in the sense
that other property is reproduced, and its value does not appear in the
capital account of the railroad; and third, it results from the action
of the seasons on the one hand, and the working over of the roadbed by
the maintenance forces on the other, the cost of which appears in
operating expenses. One is constrained to believe that the engineer who
insists on incorporating such an element in an appraisal of the physical
value of a railroad is hard put to find material with which to swell his
estimate. When noting the large difference in value per mile of the
railroads of Minnesota, as compared with those of Michigan and
Wisconsin—adjoining States—it would appear that undue prominence had
been given to this and similar factors.
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 practice 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 railroads. It would appear highly illogical to
advocate that these increased values should be multiplied by 3—or even
1½—and used as a basis for taxing the railroads on the one hand, or
taxing the public on the other, by permitting indebtedness to be issued
against it, the interest on which the latter must pay. The railroad
recently constructed by the writer traversed fertile and thickly
populated areas, already quite well served with transportation
facilities. Only a small fraction of the necessary real estate was
purchased by the railroad company, and only 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 towns, land was acquired at practically its
fair market value. For rural property, the ratios used by Professor
Taylor in the Wisconsin appraisal appear to be quite fair, but in cities
they are too high—especially for the Southwest. The Minnesota ratios
appear to be unreasonably high.
Any appraisal of the physical value of railroads—in the absence of
figures as to their actual cost—is necessarily only approximate, and is
correct only within certain limits. Especially with regard to the old
roads, where original cost data cannot be had, the values applied to
property and construction must be largely speculative. It is impossible
to build two railroads in the same territory, on the same
specifications, for the same amount; yet, on the basis of cost of
reproduction, an appraisal board must apply the same value to each.
The writer believes that unless there is more uniformity as to methods
of valuing corporation property, as between the States, all valuations
will be more or less discredited, as they should be, by the Courts. It
is to be hoped that this paper will be generally discussed by the
Profession, and will lead to the adoption of more uniform methods.
CHARLES H. LEDLIE, M. AM. SOC. C. E. (by letter).—The following is
suggested as a method of procedure for determining the fair and
equitable value of a property:
1st.—Examine carefully the statutes governing corporations of the class
under examination.
2d.—Form an opinion as to whether or not the locality can support such a
property, by inquiry regarding the different businesses carried on, bank
clearings, railroad facilities, what the surrounding country produces,
etc.
3d.—Find from the archives of the company a general description of the
property, from its conception to the date of appraisement.
4th.—By close examination of the minute books, directors and executive
committees, there can be ascertained all the details of organization,
issuing of stock, bonds, and other forms of indebtedness, contracts for
equipment, supplies used in the construction, etc.
5th.—Obtain from the general manager or the superintendents an
explanation of the details of operating and maintaining the property,
including the different classes of service, rates, etc.
6th.—Go over the property, examine it carefully, and talk to any and all
employees from whom it is thought that any information can be gained.
The foregoing will give a general knowledge of the property under
examination, and will enable one to begin the real work. The examiner's
assistants must be competent and experienced men.
7th.—Examine all the vouchers, from the beginning of the company down to
the date it began operation; classify their contents under the
respective heads for the different classes of material used in the
construction, for example, pipe, engines, cable, etc.; then prepare
blank tables for each heading, having columns for size, quantity,
prices, and total; and abstract each voucher. Do the same with the
vouchers for labor, general office salaries, general expenses, interest,
taxes, legal, etc. This, when completed, will give the detailed cost, as
shown by the vouchers.
Next check the vouchers back through the books, and draw up a statement,
which will show the total book cost and, no doubt, will differ from the
voucher total. It is likely that many items will be found for which no
vouchers exist, a list of these is made and if the officers cannot give
a satisfactory explanation of any of them they are omitted. The total of
what remains is added to the voucher total and represents the cash
expended for the benefit of the original property, as shown by the books
and vouchers.
8th.—Take all the remaining vouchers of the company (it is supposed that
the examiner has already been informed by the officers, and by his
inspection of the records, of the extensions and betterments which have
been made), separate the vouchers for materials, labor, etc., from those
on operating, etc. Next classify them by years, and then proceed as set
forth in 7th, and add the different yearly amounts to the total of the
original plant. This will show the amount of cash expended (according to
the vouchers and books) on the property, for its physical plant,
organization, etc., from its beginning to the date of appraisement.
Every examining engineer should know (or can obtain) the prices for
materials, labor, etc., during these periods of original construction,
extension, etc. If the prices are the same, or about the same, as at the
time of purchase, the above total stands as the cash expended; if there
should be much difference—and sometimes there is—take the detail of the
materials as found in the vouchers, affix the proper prices, and do the
same with labor, etc., and this total will be what, in the judgment of
the examining engineer, the plant should have cost. A mean between this
latter total and that in 8th is taken, in order to be fair and
equitable. This amount, in place of that given by 8th, is then used as
the cash expended on the physical property. If no difference is found in
prices, then the total cash as shown by 8th is considered as the total
to be hereafter used.
9th.—A careful detailed inventory is now made of the physical property
as it exists at the date of examination. This often requires some
excavation in order to determine sizes, quantities, and conditions. The
prices used to ascertain the total of the inventory are made by taking
the average of all those paid for materials, labor, etc., of the same
class, during each year of the property's existence. (The writer
considers it manifestly unfair to use the current prices in this
calculation, for they may be very much below or above those actually
paid, and in either event an injustice would be done, whereas, if the
average prices are used, the examiner cannot be accused of unfairness.)
To this total cost, as shown by the inventory, 5% is added for
engineering and superintendence; 3% for general office salaries, 2% for
general expenses, 1½% for legal and organization expenses, and from 5 to
10% for contingencies. (This latter percentage depends on the judgment
of the examiner, who, after studying the local conditions carefully, can
determine from his own experience what difficulties have been met in the
construction. It is not believed that a hard-and-fast rule can, in
equity, be laid down for this latter percentage.) This total represents
the value of the tangible property, based on the inventory. The
inventory cost and that set forth in 8th (or possibly as modified by
prices current when the plant was built) are averaged, and this result,
plus the supplies on hand, is the fair and equitable amount of cash
which has been expended on the property. This is used in finding the
"Fair and Equitable Value."
10th.—Next take the inventory of the plant set forth in 9th, affix the
current prices at the date of appraisal, and to this total add the same
percentages for engineering, etc., as set forth in 9th. This gives the
cost of reproducing the property, with the same classes of materials,
size and make of engines, etc., as is now in it, to which total add the
cost of materials on hand for the total of cash required to be expended
at current prices to reproduce the plant as it exists.
It is often found that this latter total is greater than that set forth
in 8th, for the reason that the engines, etc., may be of types which are
now abandoned or obsolete, and the manufacturing company, having to make
patterns, etc., would charge more for them than the original price at
the date of purchase.
This reproduction cost at current prices is only to give the examiner
information he may or may not require later in the investigation to
determine some point that might arise in ascertaining the "Fair and
Equitable Value."
The writer considers it unfair to call the reproduction value the cost
of a modern plant which will give the same service and output, because
one is not dealing with the value of a modern plant, but with that of an
existing property.
11th.—From this cost (using the detailed inventory to find the extent of
property still in existence), calculate the amount of depreciation for
each section of the plant, this being based on the present condition of
the different parts and what their future life may be. The total
depreciation is then deducted from the result found in 9th, and this
remainder is used as the "Fair and Equitable Value" of the tangible
property at the date of appraisal.
The intangible value (called by many names) must now be determined. It
consists of rights, from the State, county, city, or any one or more
combined, which the company must have in order to carry on its business.
These rights in nearly all States are taxable, and taxes are collected
on them. The Supreme Court of the United States has in the past held
that they are property, notwithstanding what State "Courts and
Commissions" have set forth on this subject, and in the writer's
examinations they will be treated as property until the Supreme Court of
the United States decides otherwise.
There are in general three classes of franchises, namely:
I.—Those granted by the State to conduct a business, where no county
or city franchise is necessary, only requiring the company to obey
the ordinances for excavation, etc. The charter of the Laclede Gas
Company, of St. Louis, Mo., is an example of this class.
II.—Those granted by the State to carry on a business subject to a
county or city franchise.
III.—Those granted by a city to an individual, singular or plural,
or a company, to do business within its limits or a section thereof.
In each case the right may be a contract, for it may require a payment
for the franchise granted, either in a lump sum or in yearly
installments, or in the form of services rendered, such as for light,
etc., free service of some kind, or a combination of any two or all of
them.
The manner of determining the value of "Intangible Property" is as
follows:
(_a_) The gross collected earnings are audited for each year during the
period the company has carried on its business. The same is done for all
vouchers, _i. e._, operating, maintenance, salaries, legal, general
expenses, interest, insurance, and taxes, and includes every item
disbursed. Whatever this latter amounts to, is deducted from each year's
gross earnings as already found, and the result is the true net earnings
or deficit for each year.
(_b_) The true net earnings are added together and the mean taken; if,
in the period from the beginning to the date of appraisement, any
deficits are found, these are deducted from the total of the
plus-earnings, the result is divided by the total number of years, and
this gives the true average net earnings. This is then capitalized at
the legal rate of interest of the State in which the property is
located. The result is used as the value of the "Intangible Property."
12th.—The amount given by 11th is added to the result obtained by 9th,
and this total is the "Tangible and Intangible Value" of the property,
and the "Fair and Equitable Value" of the property at date of
appraisement.
If it is found that grave mistakes in design or judgment have been made
by not employing competent people, and money has been wasted in
construction, the plant is re-designed, for the original plant, and its
cost estimated. The same is done for each extension, using the prices
paid at the different periods, and this result is used in place of 9th,
as the cash cost at the date of appraisement.
In determining the intangible value, if it is found that the management
has been careless in order to make large net earnings, at the expense of
the physical property, estimates are made of what the property can be
operated and cared for (here the practical knowledge of operation, etc.,
is necessary), and these results, plus taxes, etc., are subtracted from
each year's collected earnings. The mean or average of these results is
considered as the true net earnings, which are capitalized and added as
set forth in 12th.
The writer holds that consumers or purchasers should not pay for
avoidable error or ignorance, and the amount of the securities issued on
the property is not considered as entering into the matter of "Fair and
Equitable Value"; when they do, the method is somewhat different.
The mean true net earnings are used in determining the intangible value,
because franchises have average values, as earnings and expenses
fluctuate in corporations, and, when intangible values are to be
considered, they must not be based on the last year's net earnings, for
if they are, they may give a very large result in one year and a small
one in the next; therefore, to be fair, the mean true net earnings
should be the basis of the intangible value. If the company has been
over-capitalized, and no sinking fund or depreciation has been set
aside, it is the present owner's misfortune. If the company calls
something a betterment, and it is found that the betterment has only
replaced something, it is not allowed, but is classed as maintenance; on
the other hand, if the replacement is larger, and capable of rendering
greater results, such as a larger engine, pipe, cable, etc., the cost,
less the cost of what it replaces, is allowed as a betterment, and if
the old part is sold the proceeds are deducted from the betterment
charge, for if it is credited to maintenance, it increases the true net
earnings. This is often done, but is not the correct way to treat the
matter, for it increases the intangible value.
13th.—When new rates are to be established for a period of future years,
the manner of determining the "Fair and Equitable Value" is the same as
has been heretofore set forth. The new rates are based on averages, and
the first step necessary is to ascertain what gross revenue the company
must have in order to pay all classes of operating expenses,
maintenance, depreciation, taxes, interest on the "Fair and Equitable
Value" of the property, and a reasonable profit.
To obtain this amount, the procedure is as follows:
(_a_) Find the percentage of increase of the operating expenses for each
year over the prior one, for a period of generally five years preceding
the date of examination (a longer time may be taken if, in the opinion
of the examiner, it is necessary), and then ascertain the average annual
increase of the percentages. The result thus obtained is taken as the
increase percentage for the operating expenses for the new period of
time.
(_b_) In order to determine what the operating expenses will average
during the time the new contract is to run, take the amount of the last
year's operating expenses as a basis and add to it the percentage found
by (_a_). This total is the operating cost for the first year of the new
contract. The amount for the second year is found by adding to the cost
of the first year the percentage found by (_a_), and so on for each year
of the new period. These results are added together and their average is
then used as the mean cost of operation for each year during the full
period.
(_c_) The same method is followed for maintenance and taxes, in order to
find the average maintenance and taxes for the new contract's life.
(_d_) Depreciation on the plant begins from the date of appraisement,
and is estimated on the physical property by using for each section the
percentages used in determining the "Fair and Equitable Value."
(_e_) Interest at the rate of 6% is allowed on the "Fair and Equitable
Value," and 6% profit.
The question of extensions and betterments to the original plant must
now be taken into consideration.
(_f_) The amount of the betterments and extensions have already been
found for each year of the property's existence, and an average of them
is taken as the amount the company will spend on extensions, etc.,
during each year of the new contract. On this sum 6% interest and 6%
profit is allowed, and, for depreciation, the same percentage as used in
the original plant.
It will be seen that all the expenses of operation, etc., of these
extensions have been allowed in (_b_), where the increase has been added
for each year for these extensions and betterments, as they are assumed
to increase the cost of operation, etc.
(_g_) The amounts found by (_b_), (_c_), (_d_), (_e_), and (_f_) are now
added together, and to the sum 5% is added for interest, taxes,
operation, etc., which may be caused by the necessary increase in
capital expenditures, for a greater growth than could be foreseen at the
time the new rates were established, for losses, etc. This total is used
as the basis for establishing the new schedule of rates.
14th.—The next step is to determine what part of the amount found by
(_g_) must be paid by the different classes of consumers.
(I) First ascertain the yearly percentage of increase in the output of
the plant for the five years before the new contract is to go into
effect (or longer if, in the opinion of the examiner, it is necessary);
then find the average increase of percentage during the before-mentioned
five years. Add to the last year's output the percentage found above,
this result representing the output for the first year of the new
contract. Continue this operation for each year in the same way as the
operating expenses were found in 13th (_b_). The average of these
results will be the average estimated output during the life of the new
contract.
(II) Next find the amount of the total output each class of consumers
used during each of the five years, and then find the average yearly use
during this period. Put these into percentages of the amount of the
average output for the five years, and then use the percentages as the
amount each class of consumer will use of the average output found in
(I) during the period of the new contract.
This gives the average amount of the output each class of consumers will
use during the average life of the new contract.
(III) Next find the average percentage of the total revenue each class
of customers paid during the five years. Take these percentages as the
average percentage each class will pay of the average revenue necessary
during the time the new contract is to run.
(IV) Having found the average amount of the required revenue that each
class must pay, and the average amount of the total output each class
will use, dividing the former by the latter for each case will give the
rate each class is to pay during the new period.
It is often found in plants that large extensions have been made to
supply a special contract for a long period of time, and these
extensions are set aside for the exclusive use of this contract. In such
cases exclude the cost, etc., of this part of the plant from the "Fair
and Equitable Value" in the matter of adjustment of rates.
In determining the operating expenses, etc., in such a case, find the
percentage of the total output this special output amounts to; then,
using this percentage, find what part of the total power-house expenses
of all kinds are caused by this special contract. This result is
deducted from the total power-house expense, and the remainder is the
power-house cost of furnishing the consumers with their share of the
total output. If it is found that special employees are required to
deliver this special output, their cost is deducted, and the same for
the maintenance material used. Taxes and interest on the cost of this
special equipment are found by ascertaining the percentage this cost of
the special equipment bears to the whole plant.
The above results are deducted from the total operating, maintenance,
taxes, and interest disbursements, and "Fair and Equitable Value," and
the remainders are used as the cost of the last year's expenses for
furnishing the consumers with their share of the product and the "Fair
and Equitable Value."
The same method is used in determining the revenue paid by the consumer.
The above result, _i. e._, cost of operating, etc., is then used as the
basis for estimating the expenses for the period of the new contract, as
heretofore set forth.
If the charter comes under Class II or III, the city no doubt has
incorporated a clause for the adjustment of rates, and the method used
above is followed.
15th.—Where the franchise has expired and is going to be renewed, the
same method holds.