Read Ebook: The Valuation of Public Service Corporation Property Transactions of the American Society of Civil Engineers vol. LXXII June 1911 ASCE 1190 by Riggs Henry Earle

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Ebook has 666 lines and 86119 words, and 14 pages

PAGE

INTRODUCTORY 1

THE RELATION OF PUBLIC SERVICE, OR QUASI-PUBLIC CORPORATIONS, TO 6 THE PEOPLE

EXPLANATION OF TERMS 16

THE MICHIGAN STATE APPRAISALS 20

Organization 20

Office and Field Methods 37

Special Problems of the Mechanical Department 46

Overhead Charges 49

Right-of-Way Values 52

Non-Physical Values 64

History and Results of the Michigan Appraisal 67

RAILROAD APPRAISAL OF THE STATE OF TEXAS 71

RAILROAD APPRAISAL OF THE STATE OF WISCONSIN 75

THE MINNESOTA STATE RAILWAY APPRAISAL 77

THE WASHINGTON STATE APPRAISAL 79

THE VALUATION OF TRACTION PROPERTIES IN CHICAGO 94

THE COMMERCIAL VALUATION OF RAILWAY OPERATING PROPERTY OF THE 97 DEPARTMENT OF COMMERCE AND LABOR

THE EXTENT OF APPRAISAL PRACTICE 99

REVIEW OF SOME METHODS OF VALUATION, AND SOME OF THE CRITICISMS ON 101 THE MICHIGAN APPRAISAL

THE DETERMINATION OF ELEMENTS OF VALUE AND METHODS OF VALUATION BY 112 THE COURTS

PHYSICAL VALUES AND METHODS FOR THEIR DETERMINATION 128

The Preparation of the Final Figure 150

NON-PHYSICAL VALUES AND METHODS FOR THEIR DETERMINATION 150

CONCLUSION 165

BIBLIOGRAPHY 168

DISCUSSION

FRED LAVIS, M. AM. SOC. C. E.--The author states that his paper is confined to "a discussion of the methods which should be used in arriving at a correct figure of cost of reproduction and depreciation," and that "it does not take up questions involving the propriety of those figures when reached." In so far as this is concerned, it is probably the most complete compilation of the available information on this phase of the subject which has yet appeared in print. The author refuses to recognize that the consideration of the so-called intangible values has any place in a physical valuation. As, however, there exists such a widespread feeling, especially among those interested in railroads, that physical valuations, for any purpose whatever, are absolutely useless, because these intangible values are not or cannot be included, it does not seem out of place to refer to this phase of the subject at this time, and more especially in view of the fact that many persons, the prominence of whose position entitles them to consideration, have taken this point of view very recently, and their remarks have received considerable publicity. Not more than two weeks ago, Judge Lovett, the head of the Harriman System, expressed the opinion that the theory of valuing railroad property by trying to determine the cost of reproduction was utterly impractical. It seems important, therefore, that we, as engineers, interested in having the question properly understood, should be careful, in referring to valuation, to make it plain that other features besides the value of the physical property are to receive due consideration. The speaker, therefore, proposes to examine some of the arguments advanced by the opponents of valuation to see if the objections most generally brought forward are insuperable.

Some critics of valuation go so far as to say that engineers cannot make a close valuation of even the purely physical property. For instance, Mr. W. H. Williams, Vice-President of the Delaware and Hudson Company, in a paper on this subject, states that:

"No engineer in estimating on the several important items of construction work for the year will come within 10 per cent. of the total aggregate cost. Many of the more important items are frequently underestimated 25 to 50 per cent."

He cites, as an especially good illustration, the Panama Canal, the original estimate of the cost of which was 0,000,000, though the present estimate is 0,000,000. Almost every one who has kept in touch with that subject knows why the Panama Canal has cost more than the original estimates, and that the greater cost is no reflection on the judgment of the engineers who made such estimates. One cannot always foresee what changes in plans may be made before construction is completed, and would hardly expect the estimates of the cost of a railroad to be adequate if they were made for a single-track road and a double-track was built. In any event, there is a vast difference in estimating the cost of an engineering work already completed and one which has yet to be started, the difference being largely in favor of a closer estimate of the completed work.

Limitations are often placed on engineers, in connection with work they do, which are afterward forgotten. The speaker was asked not long ago to prepare a report in connection with the valuation of a large railroad property. The time within which the results were required was very limited, and the methods used in the valuation necessarily had to be a combination of the inventory method and reliance, in a great many matters, on the judgment of those making the appraisal. Undoubtedly the result obtained was entirely adequate for the purpose for which it was required, but would hardly stand if an attempt were made to use it as a basis for an argument before a Court of law or a public service commission, though it would not be beyond the range of the experience of many engineers to have a matter of this kind brought forward some time in the future as an absolute statement of fact, with no reference to the way in which the work was done.

It is inevitable, of course, that engineers will differ in their opinions as to some details of methods of making an inventory of the property of a railroad or other public service corporation, and also as to exactly what unit prices should be applied, but in general it is safe to say that any engineer of proper experience and training can make a satisfactory appraisal of the value of the physical property of a railroad, and that if two or more such competent fair-minded engineers, unhampered by any consideration of the purpose for which it is to be made, should make such an appraisal, the variation in the result would be so small as to be negligible. The speaker, however, does not entirely agree with the author, that the purpose for which the appraisal is to be used should be entirely ignored by those who are making it. There can be little doubt as to the propriety of using a properly made physical valuation as a basis for taxation, or as information for the owners, although there may be some as to the methods whereby the so-called intangible values are to be determined in these cases, or even whether they should be considered at all. The greatest difference of opinion arises when an attempt is made to regulate the issue of stocks and bonds, or to fix the rates which should be charged for transportation, on the basis of a physical valuation.

Arguments for and against rate regulation revolve in a circle, and, apparently, there is no starting point which will satisfy every one. The Courts have ruled that the railroads are entitled to such rates as will enable them to earn a fair return on the value of their property; the railroads claim that the only way to determine this value is on the basis of the earning capacity; that is, one side claims that the rates must be based on the value and the other that the value should be based on the rates. It is evident, however, by this time, that the railroads must submit to regulation, therefore a way must be found to break into the circle, and it would seem to be incumbent on them to direct their energies along lines which will tend to make such regulation fair and just rather than to oppose it entirely. There is little claim that unduly large dividends are paid, but there is a feeling in the mind of the public that the railroads are over-capitalized. Is it not possible, therefore, to break into the circle at this point, and decide, by means of a proper valuation, as to the fairness or otherwise of the capitalization? The objection to this, on the part of the railroads, is that the value of the purely physical elements is by no means the whole value of their property, but that something should be added for the so-called intangible values.

To emphasize the difficulties of appraising the intangible values in any way which will permit the application of such value to the determination of rates for transportation, the opponents of physical valuation cite what is now the familiar instance of two mythical roads between the same termini, the first with good alignment and easy grades following a valley, and the second forced into the mountains, having not only heavier grades and more curvature, with consequently a higher cost of operation, but also more expensive construction. The value of the purely physical features of the former, of course, would be much less than those of the latter, but its actual value as a property would be greater. How then should the rates on the two roads be fixed? The fallacy of using this example as an argument against physical valuation as a basis for rate-making is in assuming that there would be two railroads built under such circumstances, with no other features than the two termini and the line between.

One has only to call to mind such examples of competing lines as those of the Denver and Rio Grande between Denver and Salt Lake, the Union Pacific between Cheyenne and Ogden, the Lackawanna and New York Central between New York and Buffalo, or many others, to realize that there are, on all roads of this nature, many other factors than the actual cost of operating through trains between the termini, which determine the through rates.

The example is far-fetched, and in no way applicable to the question of the adjustment of rates on railroads, but inasmuch as it is seriously put forward from a responsible source, it seems worth while to consider it.

"The scheme of physical valuation, as a basis for rate making, is flatly rejected as unworkable by practically all the ablest railway authorities of the country, and that the only true measure of value is the earning capacity."

To quote only one, namely: Dr. Emory R. Johnson, who is generally regarded as an authority and not by any means predisposed in favor of the public as against the railroads, it is found that he states in his "American Railway Transportation" that:

"The earning capacity of the railroad cannot be equitably or logically made the sole criterion of value, because the rates, and hence the earnings, should depend to some extent, at least, upon the amount of capital justly entitled to profit."

It would seem to be self-evident that the earnings alone, either gross or net, are not necessarily an indication of the value of the road. Gross earnings are not, because, if a minimum proportion of them is used for maintenance and betterment, the value of the property will steadily decrease; whereas, if the opposite policy be followed, it will increase. On the same principle, the net earnings offer no criterion as to the manner in which the property has been kept up, and alone are, therefore, no measure of its true value.

As an example of the arguments used by some of the opponents of physical valuation, the following quotations are made from an article by Mr. Henry Fink, Chairman of the Board of the Norfolk and Western Railway. Referring to the fluctuation in the costs of construction, he says:

"As the cost of materials and labor fluctuates ... it follows that what may be a fair valuation of a railroad one year may not be so one or two years later. Hence, it would be necessary to make new valuations from time to time."

Further, in the same article, referring to a valuation based on the market value of bonds and stocks, he says:

"Unlike the physical valuation, this method has a rational basis.... It is true that prices of stock fluctuate--at times violently--but this difficulty can be overcome in a measure by using the average prices for long periods."

It is strange that it did not occur to so able a man as Mr. Fink that the value of the physical property might also be based on average prices for long periods; the cost of railroad construction and equipment as a whole does not fluctuate nearly so violently as the stock market.

The report on "The Basis of Unit Prices," by W. D. Pence, M. Am. Soc. C. E., the Engineer of the Wisconsin Railroad Commission, in connection with the Appleton Water-works case, is an excellent example of a fair and impartial study of this phase of the subject, and the conclusion of the Commission in this matter can only be regarded as reasonable by any one who is disposed to be at all fair-minded. It says:

"If the standard by which the reasonableness of charges is to be determined should fluctuate with the market prices of material, labor and land, no schedule of rates could be established for any length of time, for, under the circumstances, a rate that would be reasonable to-day might be very unreasonable to-morrow. The principles of the law applicable to the subject certainly involve no such absurd consequences."

"It has been supposed in the past that rate-making is an exercise of judgment. It seems to be assumed by many that after a valuation has been made it will be merely an exercise in mathematics. Suppose the value of a railway for state purposes is ,000,000. Then, on this theory, all that will have to be done will be to multiply this amount by 6 per cent.--or whatever may be regarded as a fair return--and so adjust the rates as to enable the road to earn, say, ,000,000 a year," but, the writer goes on to ask, "how are the specific rates to be fixed? A great majority of those who advocate valuation say that they should be based on the cost of the service. The proper method, then, would be to ascertain the exact cost of hauling each commodity and then base rates on these ascertained costs, making them just high enough to allow the road a fair return."

Then the article goes on to point out the difficulties of doing this, which of course we all know, and finally concludes that: "The theory of basing rates absolutely on the cost of service is unjust and impracticable." In the present state of the art this is probably true, but why is it necessary to change the present theory of rate-making because the rates are to be lowered or raised? If, for instance, it is shown that it is necessary to reduce the rates sufficiently so that the net earnings will be reduced, say, approximately 10%, is it beyond the capacity of the traffic officials of a railroad to adjust their rates accordingly?

"It cannot be said that ... railroads make tariffs; they can only adjust them to varying conditions."

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