on present conditions, and also on possible future conditions
which might be involved in a renewal of the City contract, which
was to expire within two years.
That these determinations of value, from different points of view, had
an influence in moulding the opinion of the individual appraisers, there
can be little doubt; yet it is probably equally true that in no case was
like weight attached to the several items or bases of valuation.
Nevertheless, in the final valuation, the consensus of opinion as to the
value of the property, as a whole, was remarkably close, the extreme
variations in opinion being approximately 8%, more, or less, than the
final appraised valuation.
Attention should also be called to the necessity, in any valuation by
capitalization of income, such as that outlined by Mr. Riggs and used by
Professor Adams in the U. S. Government Valuation of Railroads,[46] of
determining whether the plant or property is in what might be termed an
over-built, normally developed, or under-built condition; in short,
whether the investing public has correctly gauged its momentary physical
condition with reference to its bearing on the rates, and whether the
earnings are in fact inadequate, commensurate with the service rendered,
or excessive. In the long run, due weight will be given to these facts;
in a brief period, they may be incorrectly gauged. In water-works
properties, unfortunately, there is rarely, if ever, a market price of
the securities which can be said to be credible or significant in
valuation. Therefore, in the valuation of water-works properties, it is
the more important that the appraisers should weigh carefully the
present character of the service furnished and the momentary adequacy or
inadequacy of the rates as predicated on such service, on the needs of
the community, and the existing standards of the day, if full justice is
to be done.
In conclusion, the writer reiterates his statement, that he has taken
issue with the author in no carping spirit of criticism, but with a
recognition of the difficulty and complexity of the work of appraisal,
and the conviction that engineers are under a moral obligation to do an
educational work in pointedly calling attention to the fact that the
going, or going concern, value, of a public service corporation's
property is not an intangible value representing an unearned increment,
but a very real and substantial item of cost in the property as a whole.
While the difficulty may be met by placing going value, as suggested by
the writer, in a middle class between physical plant and intangible
values, the placing of it in the same class with franchise and other
intangible elements of value, as suggested by the author, may, in the
judgment of the writer, do a serious injury to corporations, in failing
to give expression, in such a manner as shall be clearly within the
grasp of the popular mind, to the fundamental idea of the cost of
developing going value. While the writer has no personal interest in the
matter, on one side or the other, having served both municipality and
corporation in water-works valuations, he feels, nevertheless, that
engineers can do a genuine service, alike to the public and to the
public service corporation, in laying stress on the fundamental elements
of cost and value, and particularly those on which rates should be
predicated, in public service corporation property valuation and rating.
CHARLES HANSEL, M. AM. SOC. C. E.—So much has been said on the subject
of valuation of public utilities that, although the speaker has thought
on the subject for ten years, and has done considerable valuation of
railroad properties, he finds that he is considerably confused, for the
reason that the discussions seem to cover the whole field of
engineering, accounting, taxation, and economics; therefore he suggests
that, in order to get down to a basis of usefulness, a special committee
should be appointed to take this question under consideration.
The speaker had the honor of being associated with the Michigan
Commission, as a member of the Board of Review. Professor M. E. Cooley
was selected by the State of Michigan to take charge of the work of
organization, and Mr. Riggs was the engineer who organized the office
and field forces. Both these gentlemen were eminently successful in that
very difficult work. Mr. Cooley did this Board the honor of saying that
there were so many problems coming up in actually carrying out the work
(aside from the theories of taxation, rate-making, accounting, and
several other things, which could be found more readily in the Auditor's
office than in the Engineer's), that he had asked for the appointment of
this Board of Review, to sit as a Court, and to pass on the many complex
questions arising from day to day; and he had the satisfaction of coming
to the Board every day and saying: "Well, now here is a condition, and
how will I handle it?" Of course, actually, he knew more about it than
the Board, but he was kind enough to say that he would ask for the
Board's opinion. That Board adjudicated all these various questions to
the best of its ability, and the speaker has the satisfaction of knowing
that the valuation has stood in the Federal Courts. The subjects are so
fugitive and so illusive that very much depends on the point of view.
The speaker is now engaged in the actual task of trying to place a
valuation on some $300,000,000 worth of property in New Jersey,
involving the most important terminals in the United States.
The valuation of public service utilities is the most profound question
which has ever been before the Society, and it includes a great deal
which is outside of strictly engineering questions; in fact, the
discussions do not throw much light on the methods which should be
followed in making valuations.
The terminology of a subject is very important; in fact, the speaker has
found it so important that in his discussions with the Attorney-General
of New Jersey, in reference to the Railroad Tax Law, which he has been
asked to re-draft, that draft will be accompanied by a glossary, so that
the meaning of certain terms used in that particular Act will be clear.
In this New Jersey work some eighty-seven engineers and assistants are
employed, and for their guidance the speaker has prepared thirty-five
pages of very carefully considered instructions. These instructions are
accompanied by blue prints showing exactly how all field notes must be
recorded, with diagrams of trusses, culverts, and the like, and all the
elements of railroad construction.
The Tax Law of New Jersey states that, first, the true value of the real
estate shall be ascertained; second, the true value of the tangible
personal property; and the first law of 1884 stated: "and third, the
value of the franchise"; but somebody discovered that there was
something besides the value of the real estate, the tangible personal
property, and the franchise. They did not know what it was, but there
was something else; therefore, in the 1888 law they changed the third
division of value to read: "the remaining property, including the
franchise."
As an example of one of the difficulties of determining classification,
attention is directed to the term, Real Estate, which is broadly, but
seldom accurately, understood.
The Interstate Commerce Commission is the highest tribunal in the land,
in the matter of railroad accounting, but it affords no help in many
important elements of value; for instance, under the Interstate Commerce
Commission, real estate includes only such real estate (land) as is not
required for railroad purposes. All land actually used for railroad
purposes is classified under "Right of Way and Station Grounds."
When the engineers on the New Jersey valuation were sent into the field,
it was necessary to specify exactly what elements must be described as
real estate, and what as tangible personal property. The division line
had to be defined accurately for the reason that all personal property
is assessed permanently to the State, while, in the case of real estate,
the State receives the taxes on a strip not exceeding 100 ft. in width,
and the tax on all property used for railroad purposes outside this
strip reverts to the taxing district wherein it is found.
The vexatious question as to whether machinery is to be considered as
real estate or personal property was settled by the New Jersey Law,
which says that tangible personal property shall include all machinery;
but it left unsettled the question: what is machinery? After careful
consideration, real estate was divided into 74 classes, and all other
tangible elements were classified as personal property. Some of the
items of real estate are: ash-handling machinery and the like, chimneys,
cisterns, conveyors, dams, locks, lock machinery, electric wiring,
piping, heating, interlocking, signaling, pavements, reservoirs, shop
fittings, tanks, telegraph lines, track, track scales, transfer tables,
water-works, etc., etc. Generally speaking, all items of a fixed
character were included in the 74 divisions of real estate.
The difficulties of determining all the elements of real estate are
mentioned simply to call attention to what at first glance seems quite
simple, but on close examination is found to have great complexities.
The question of useful life depreciation, direct and indirect, due to
decrepitude or obsolescence, or both, is one of the illusive questions;
and then comes the value of the franchise.
The valuation of railroad property in New Jersey is further complicated
by the requirements of the State Tax Law, which specifies that the value
of the remaining property, including the franchise, shall be determined
after the "true value" of the real estate and tangible personal property
have been determined.
The speaker will not attempt a discussion of franchise values, as it is
a subject which requires the most profound study.
The author states that he is appalled at the speaker's misconception of
the method of determining non-physical value used by Professor Adams in
Michigan. The speaker is perfectly familiar with that method, and,
although having the greatest respect for Professor Adams' opinions, is
compelled to draw attention to two important elements of that formula
which are open to objection.
Professor Adams establishes his annuity on the depreciated value, rather
than on the cost, or the reproduction cost, which, in the speaker's
opinion, does not determine the proper annuity or reasonable fixed
charges to be deducted from net income before net surplus is
established. Bonds are generally sold at a considerable discount, and
represent the full cost plus this discount, consequently, the interest
on bonds or fixed charges will be greater than an annuity established on
cost, "reproduction cost," or "present value." Would it not more nearly
establish fixed charges or annuity, to take the cost plus discount and
commissions as the basis on which to apply the annuity rate?
While Professor Adams' formula establishes a larger net surplus for
capitalization than the method suggested by the speaker, he in effect
destroys this net surplus by charging against it all betterments
chargeable to income. It is quite clear that this gives the railroad
company a chance to absorb all net income into betterments, and thus
wipe out all net income, in which case there would be no net surplus to
capitalize, consequently, no non-physical or franchise value, and the
total value established under this plan would be less than if the
property had not been improved by the betterments—_reductio ad
absurdum_.
In reference to the question of whether or not the method of valuation
should be the same, regardless of the purpose to which the value is to
be applied, the speaker cannot agree with the author, and believes that
it is quite consistent to establish different values for different
purposes.
The completion of a large public utility, planned on such a scale as to
provide for the requirements of many years to come, utilizing but part
of its capacity, and earning less than its operating expenses and fixed
charges, with its rates of toll fixed by law, must be considered in a
different way than a well-established public utility, with business
forcing it to its utmost capacity, and with tolls not fixed by law.
There are many important elements bearing on this consideration of
value, and the purpose of the valuation should be known before
attempting to establish the value.
In New Jersey the work is complicated further by the necessity of
establishing the value of 122 separate railroad corporations, and the
assignment of all property outside the 100-ft. strip to each of the 450
taxing districts through which the 122 corporations, with their many
branches and spurs, are operating.
In order to determine the quantities and materials in the permanent way
and structures, nine engineer corps were organized, each corp consisting
of six men. With this force the center line of the main running track
was measured, and the exact distance in each taxing district recorded.
Cross-sections of the roadbed were made as often as changes in the
natural surface required, and accurate measurements and notes were made
of all structures; and, although in many cases the engineers were able
to secure the plans of the more important steel structures, the field
parties were required to obtain sufficient data to compute the tonnage
in case it was impossible to get these plans.
The field parties were also instructed to note the character of the land
and improvements adjoining railroad property, and record such other
information as was necessary for a comprehensive understanding of the
conditions attendant on the construction of a railroad in that locality.
The time allotted for the completion of the work is one year, and
although this is a comparatively short period in which to introduce a
premium system in field work, it was decided to inaugurate such a system
as would be as nearly satisfactory as possible under the conditions. A
record of each field force for each day in each month was made on
profile paper, using the horizontal lines to represent the number of
tracks, and the vertical lines to represent distance. Two horizontal
lines were allowed for single track, four for double track, and so on.
One mile was allowed for each vertical division of the paper, and, in
awarding the premium, there was taken into consideration, not only the
extent of territory covered by each field party, but much consideration
was given to the field notes, and a cash prize was awarded each month.
The results of the organization and encouragement to the field parties
are shown by the very great increase in the amount of work per man of
the field parties, which was nearly 300% during the time the parties
were in the field.
A great many questions hinging on interstate commerce, and involving
Fundamental, State, Federal, and International Law, are embraced in the
broad view of the valuation of railroad properties. The movement of
rolling stock through various States, and between the United States,
Canada, and Mexico, and the determination of the situs and domicile of
floating equipment, are subjects which, not only require considerable
knowledge of railroad operation, but involve many questions not clearly
determined by the Courts.
The subject is of such great importance that steps should be taken to
formulate methods of procedure, and, at the Annual Meeting of the
Society, the speaker will offer a resolution requesting the appointment
of a Special Committee to determine the proper methods to be used in the
valuation of public utilities.
J. MARTIN SCHREIBER, M. AM. SOC. C. E.—Engineers and those generally
interested in the valuation of public service properties are fortunate
in having the valuable information embodied in this paper. Although
there are some points on which the speaker differs with the author, the
following remarks are only offered in order to bring out, from
experience, some further phases of the subject, rather than as an
attempt to criticize.
A great deal is heard about the exact cost of reproduction, also
arguments in reference to the proper allowance for contingencies,
probably only involving a small percentage. The speaker questions the
propriety of advocating the exact cost figures. The carefully checked
cost figures of reliable contractors, with first-class engineering
organizations, submitting proposals on the same construction, are often
found to vary from 5 to 15% from the total cost. Different organizations
will sometimes be the cause of figures varying 5% or more, depending on
the efficiency and experience of the corps. A clever purchasing agent
will reduce an apparently precise estimate on equipment or supplies as
much as 10%; on the other hand, the condition of the market may be such
that the actual price paid exceeds the estimate by the same percentage.
Engineers who are responsible for estimating on, and the execution of,
construction projects generally add more than 10% for contingencies, as
it is practically impossible to anticipate them, and a precise estimate
is almost certain to fall short. It is unfortunate that it is almost
impossible to sustain contingency figures on the witness stand; for that
reason, probably, it would be more satisfactory to the lay mind, and to
the various courts, boards, etc., which are required to pass on
valuations, and do not thoroughly understand the technicalities of the
situation, if engineers would drop the contingency item and modify the
quantities or the unit prices.
If it is possible to estimate the exact cost of reproduction, certainly
considerable variation may be expected from independent sources in
computing depreciation and present values. Yet there are reputable
engineers who would have one believe (assuming that they know the cost
of reproduction) that by a simple field inspection they are able to
compute the exact present value.
Some time ago, the speaker heard an expert testify in the interest of a
certain city, for tax purposes, with reference to the value of a piece
of street-railway track. He first stated the valuation for reproduction,
and then the definite present value. The latter was greatly in excess of
the actual value. The expert, who was an engineer of considerable
standing, on cross-examination, did not know the height of rail from top
of head to bottom of groove, either at the joint or any other part in
its length; he did not know the exact depth of flange of the car wheels
which operated over that track, the headway, or the exact weight of the
cars used. He had assumed the condition of the ties, and that the track
was ballasted. Finally, he was compelled to admit that his determination
of the depreciation, by simply a field inspection, was a very rough
approximation. Now, it is not in every case in the past that a
corporation attorney, even with engineering assistance, has been able to
point out unfair testimony. Many times the speaker has heard incompetent
testimony admitted, on the general principle that the witness was an
engineer of note, even though his record had been made in other
specialities. Too much stress cannot be put on this phase of the
subject, and the speaker is glad that the author has mentioned the fact
that the personnel of those doing appraisal work should be of the
highest order. In the past it is probable that the failure to
discriminate properly in accepting incompetent testimony (not to mention
prejudiced testimony) was automatic, and this is the most important
reason for much of the hostility of officials of public service
properties toward all forms of investigation, as the author mentions.
Company officials know that they are often compelled to employ and train
specialists to furnish, within fairly accurate limits, the very
information which is being sought, and naturally they are skeptical
about the data presented by those who, though not intimate with the
property, purport to give exact cost figures. Any one who is able to
point out a consistent method whereby these exact figures may be
obtained surely will obtain credit for a valuable contribution toward
the solution of the complex subject of valuation.
Referring to the valuation of the property of the Detroit United
Railroads, mentioned in the paper, the Director of Appraisals for the
city estimated that the cost of the complete appraisal of the property,
which includes about 220 miles of single track, would be from $3,000 to
$4,000. Approximately, $25,000 has already been spent, not including the
expense sustained by the company, which furnished a large proportion of
the information.
Probably correct present value estimates which include depreciation may
not be even fairly approximated without intimate knowledge of the
particular property, and this should embody operation, policy of
management, past performance, study of historical cost (as far as the
records will permit), estimated cost of construction, and actual cost of
maintenance. The life of a piece of track or equipment, disregarding
obsolescence and extraordinaries, generally depends on the type and
details of construction, the service it has done, and the service that
will be required of it. Renewals should be made when the cost of repairs
reaches a certain figure, other conditions being favorable. It is a fact
that able engineers, intimately acquainted with the case at issue, and
employed on the same property, often have conflicting ideas in reference
to the life of track or equipment, one recommending immediate renewal
and another advocating longer operation.
The speaker does not intend to argue against the possibility of placing
fairly accurate values on reproduction or present value, but wishes to
bring out the fact that it is not as simple as the lay mind is often led
to believe. Further than that, he is of the opinion that the following
is essential for economical and satisfactory valuations for all
concerned:
(1) There should be co-operation of the appraisers with the public
service property officials, including operators, engineers, and their
records.
(2) Present values should be determined by:
(_a_) Cost of reproduction,
(_b_) Mortality tables,
(_c_) Data of performance,
(_d_) Field examination.
(3) The organization for the appraisal work should be of sufficient
scope, and should be allowed the time and funds which the project
reasonably requires.
(4) The appraisers should be carefully selected, the personnel including
men who have had wide experience in the particular class of operation;
and specialists should be obtained if necessary.