Chapter VI: Front Matter (6)

This method, of course, cannot be used for purposes of rate-making, or of bond or stock restrictive legislation, but the general uniformity of its results with those of State appraisals, and the radical differences noted in the case of values for taxation in other States, lead very properly to the inference that a value determined by this method is very close to the truth.

THE EXTENT OF APPRAISAL PRACTICE.

There have been many appraisals of property besides those reviewed in the foregoing pages. Several excellent contributions to valuation literature, as a result of the numerous water-works appraisals, are mentioned in the Appendix.

New Jersey and Nebraska have had railway appraisals in progress during 1909-10. At the time of writing, neither appraisal has gone far enough to add any points of interest to the subject, except as the appraisers in these two States discuss the subject and bring out new points.

Valuations of street railway property have been made in several cities, Cleveland, Ohio, Detroit, and Milwaukee being the most recent.

The Cleveland and Milwaukee hearings have produced large records, and have tended to determine finally certain principles of valuation. Several valuations have also been made for corporations, among which may be mentioned that of The Toledo Railways and Light Company, by Messrs. Ford, Bacon, and Davis, and that for the New York, New Haven, and Hartford Railway, under the direction of John F. Stevens, M. Am. Soc. C. E.

This latter valuation offers some very interesting points, and, in view of Mr. Stevens' standing as a railroad engineer, the adoption by him of methods of inventory and field inspection would go far toward fixing a precedent which would be acceptable to the railroads. It is to be regretted that the interests of the road are such that it is not deemed wise by its President to discuss even the principles of this work at present.

In connection with the recent appraisal made by the City of Detroit, The Detroit United Railway made an independent examination and appraisal of its own property, with the double purpose of furnishing an inventory to the city and of checking the work of the staff employed by the city. This work for the railroad was done by officials and employees of the company, under the personal direction of Mr. R. B. Rifenberick. It is noteworthy for the completeness of its inventory, which goes into the most minute detail, and for the excellence of the maps and drawings which accompany it and show, not only every standard type of track, rail, and all buildings and machinery, but every piece of track and overhead special work on the entire system. This appraisal includes a most complete and exhaustive study of average unit costs. Inasmuch as this work is likely to be fully reviewed in the Courts in the near future, any further description would hardly be proper. It is not too much to say, however, that it probably stands as the most complete in every detail, as to inventory and records, of all American appraisals up to this date.

During the summer of 1910 the Railway Commission of Michigan ordered an appraisal of certain large electric-power properties of the State. This work was done by Professor Mortimer E. Cooley, assisted by Mr. Henry C. Anderson and the writer. This appraisal, involving certain comparatively new corporations, made it possible to obtain a fairly definite solution of some of the problems relative to overhead charges.

It is evident that the demand for valuation work of a high character will increase, and that it will come, not only from States and cities, but from corporations. Much of the work done in the past has not been described in the publications of scientific societies; much very valuable work has secured only partial notice through reports of litigation; and it is undoubtedly true that the most complete and full discussions of the principles of valuation have been in the form of expert evidence before the Courts, and are buried in the mass of unprinted records of testimony.

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

Much of the available literature on the subject of valuations is in the form of papers descriptive of water-works appraisals and arbitrations, many of which have been made, and a few of which have been the subject of valuable papers and discussions before learned societies.

Before the American Water-Works Association, D. W. Mead and J. W. Alvord, Members, Am. Soc. C. E., have presented papers[12] which have been quite fully discussed. The chief point of interest in these papers is the treatment of the intangible element termed "going value." Mr. Alvord advances the argument that, after the determination of physical present value, there should be added, to determine the fair value, two non-physical elements: the "going" or "business" value, and the franchise value. The first element is defined as that special value which is:

"Built up ... by the energy, perseverance and solicitation of the officers in charge, as distinct from the inert plant itself, ...

* * * * *

"The element of 'going value' has been before described as the element of growth in the plant irrespective of its physical condition. It is comparable somewhat to that indefinable quality known in other lines of business as 'Good Will'. Nevertheless it is something more than good will in water works business, as it represents what might be more aptly described as 'connected good will', that is to say, the acquisition of customers who have invested considerable sums in actually connecting their premises with the plant of the company, and provided appliances for the use of the water which it can deliver."

The method advocated by Mr. Alvord as the most rational one for computing this value is described as follows:

"It is assumed that a new plant will be constructed, the inception of which is coincident with the data of arbitration. Such new plant is to be of an equal capacity with the older plant under consideration, and a due allowance of time in which to construct this new plant, and the necessary capital to be invested in it from time to time is estimated. At the completion of this new imaginary plant, it is assumed that it commences to obtain business in that community from those who are not previously accustomed to the free use of public water, except in a general way; that it is to require the business ability and consequent increase in number of customers which the earlier and older plant went through within the early years of its existence. An assumption of the amount of business thus created for each year for a period of years in advance is carefully computed and estimated by the board of arbitration. The losses of interest upon capital invested are duly fixed, as well as the first absence and later addition of revenue from hydrant rentals, and a table is prepared showing each year, the total business developed and the total losses, if any. After this is completed a forecast is made of the business of the older works for the same period of time in the future that it takes the business of the new works to equal the business of the old works. If the business of the old works is found to be a growing one it will be a longer period that the new works will require to overtake it than will be the case if the business of the older works is stationary or decreasing. In general, the differences which might be called the debits and credits of this new imaginary plant and the debits and credits of the older working plant are reduced to their present worth at the time of appraisement, and an estimate is made up which will adequately represent the financial advantage which the old works (already fully equipped and in running order and having a large number of profitable customers) will have over the new works, where everything must be built and customers secured.

"It is necessary in making this supposititious estimate of the new plant to consider it in no way a competitor of the older works; there is not supposed to be competition between the new and the old, but it is left to the experience of the board of arbitration to consider how long it would take the new company to build new works, and build up business for the new works, until they have overtaken the business of the old company should it continue to occupy the same territory."

Mr. Alvord's description of his method has been quoted fully, as it is an interesting one and has been often used. It is open to the very decided objection that it is purely theoretical, a rational method of computation, perhaps, but based on assumption throughout. It may be said to be a method which is within the field of pure speculation. Mr. Alvord, himself, says that where experience in financial matters and the financial management of water-works is not brought into the valuation, there is usually to be found guesses of the wildest character. Professor Mead, in discussing Mr. Alvord's method and agreeing that it is consistent and logical, says:

"The method is by no means an exact one, and must necessarily lead to a very great divergence in opinions as to the 'going value,' in accordance with the assumptions on which it is based.... Its very logic is an element of danger, for if clearly presented from a biased standpoint to one previously unacquainted with its application, and if accepted without careful analyses it may lead to very unjust conclusions. If used, however, carefully and conscientiously with the desire to do justice to all concerned, it is a valuable method of estimating going value, and the only logical one with which the speaker is familiar."

In addition to the element of going or business value, Mr. Alvord considers the franchise value, and presents two methods for its determination:

_First._—The physical value, depreciation, and going value are entirely neglected, and the entire valuation is fixed on the basis of its earning power throughout the remaining life of the franchise and its probable sale value.

The probable net revenue for each year of franchise life must be estimated and capitalized at a sum, which, if put at interest, would pay such yearly revenue and extinguish itself at the end of the franchise period. To this must be added the physical value of the plant at the end of the franchise period.

_Second._—The cost of reproduction, depreciation, and present physical value are ascertained, and the going value computed. Then it is determined whether or not the net revenue is paying interest on a capitalized value greater than that indicated by the sum of the physical and business values. If such capitalized figure is less than this combined value, there is, of course, no franchise value; if it is more, there is a franchise value which should be determined by estimating, for the remaining years of the franchise, the excess income over and above that necessary to cancel all obligations (including interest on the physical and business values), and the reduction of these several sums to a basis of present worth.

A number of other articles and papers are listed in the Appendix. Many of these are of great value and are well worth careful perusal, but they offer no definite plan of valuation. Inasmuch as the general principles involved in the valuation of a water-works plant and a railroad plant are similar, it is advisable, in any exhaustive study of the subject, to review the articles descriptive of water-works valuation, and it is a matter of regret that greater consideration cannot be here given to some of the points raised by such engineers as George H. Benzenberg, Past-President, Am. Soc. C. E., Kenneth Allen, Arthur L. Adams, Emil Kuichling, Members, Am. Soc. C. E., and others in their various papers and discussions of this subject.

The _Railway Age_, the _Railroad Gazette_, the _Railroad Age Gazette_, and the _Railway Age Gazette_ contain many editorials and articles on the valuation of railroad properties. These are written mainly from the standpoint of the railway official, and present many matters of interest which are worthy of study prior to undertaking a large appraisal. One series of articles in the _Railway Age Gazette_[13] is a most masterly argument, and it is to be regretted that the author has not disclosed his identity.

The Michigan valuation has been discussed in two papers by Mr. Charles Hansel, whose connection with the work, as a member of the Board of Review, gave him probably a more intimate knowledge of it than any one else, not connected with the actual working organization, who has undertaken to review the work. His first paper, published in 1901,[14] entitled, "What is the Value of a Railroad for Purposes of Taxation?" is a discussion of the work of Professors Cooley and Adams, written while the subject was fresh in his mind. His second paper, an able argument for a Government valuation, appeared in the _North American Review_ in 1907. The one point to which special attention is drawn is Mr. Hansel's astonishing misconception of Professor Adams' plan of work. This misleading statement appears in the first paper and is reiterated in the second. It is of such a character that to pass it unchallenged would be doing great injustice to Professor Adams. He states Professor Adams' plan as follows: Capitalize net earnings and add to the present value of the physical appraisal as found by Professor Cooley.

"The result would be that in case the present value per mile as determined by Professor Cooley is found to be $15,000, and the net earnings by Professor Adams are found to be $1,000, this capitalized at 5 per cent. would equal $20,000, and added to the present value would make $35,000, which would be the sum upon which taxes were to be levied. In other words, if the company actually earns $1,000 it increases its value for purposes of taxation 20 times that amount. If, however, instead of having a net earning of $1,000 it spends that sum in improving the property, it has only increased its taxable property by $1,000."

This statement is not only inaccurate, but involves the other error of assuming that the appraisal figure was to be used for taxation. It was not. It was merely information to aid the legislature in framing new taxation laws. The chief error, however, is in assuming that Professor Adams added the value of the property, as determined by a capitalization of net earnings (which _per se_ is a well-recognized method of valuation), to the value of the physical property. This error probably is due to the flood of criticism which at the time was aimed at any form of non-physical valuation.

Professor Adams finds the net earning in Mr. Hansel's example to be $1,000 per mile. From this, in the method actually used, he deducts an annuity for the support of invested capital, which he assumes to be the present value found by Professor Cooley. In the example given by Mr. Hansel he would deduct 4% on $15,000, or $600 per mile, leaving $400 per mile as surplus, or the earnings due to non-physical elements of value. This, capitalized at 5%, would give $8,000 per mile, which, added to Professor Cooley's figure of Present Value, would make $23,000 per mile, instead of $35,000, as stated by Mr. Hansel.

The most recent criticism of the Michigan valuation work was in an address[15] before the New York Traffic Club in January, 1909, by Mr. W. H. Williams, Third Vice-President of the Delaware and Hudson Company. This address is devoted to an attack, not only on the work of the Michigan appraisal, but on Professor Adams' work and on the propriety of valuation work being undertaken for any reason. The arguments advanced in this address are such that a discussion of them becomes almost necessary in any complete review of the Michigan work, and it contains so many statements which are erroneous that it would hardly be permissible to pass them without comment. The manifest impatience with all forms of governmental interference with corporations, which so often characterizes the utterances of prominent railway officials, appears in this paper to a marked degree. After stating that the present agitation for a physical valuation appears to be the result of a misconception, on the part of the Interstate Commerce Commission, of Section 20 of the Act to Regulate Commerce, and quoting Professor Adams' suggestion of an inquiry, he says:

"Subsequently, the desire of Governor Pingree to find a means of increasing railway taxation in Michigan gave Professor Adams an opportunity to experiment with his project within the limits of that State."

This is a direct imputation of an improper motive, not only to Governor Pingree, but to Professor Adams. As stated elsewhere, the investigation was to determine whether the railroads were paying taxes on the same basis of valuation as other property in the State—an absolutely proper proceeding. Professor Adams was associated with the Michigan appraisal, but had no connection whatever with the "physical valuation," to which such objection is taken, and his appointment was made after the work of physical valuation had been fully outlined and was well under way.

The opening statement is followed by a brief _résumé_ of the recommendations of the Interstate Commerce Commission and President Roosevelt, and of bills introduced in Congress, also by quotations from Bulletin 21, describing the methods of valuation used in Michigan and a showing that practically a similar basis was used in other States. Mr. Williams then summarizes his objections to the Michigan work:

"(1) No allowance is made for discount on securities sold.

"Discount is a partial capitalization of the commercial risk had in making the investment, and it increases or decreases in proportion to the probability of the earning power of money under existing conditions. Not only is this practice justified by long-established commercial usage, but also by judicial determination."

The correctness of this position cannot be conceded on any grounds of economics or accountancy. It is answered conclusively in an article,[16] elsewhere referred to, as follows:

"There is considerable diversity of opinion as regards the proper treatment of discount on securities sold. There is a distinction between bonds, representing corporate indebtedness and having a definite limitation as to the time of their redemption, and share capital, representing ownership and which as a rule is irredeemable. In relation to the former there can be but one tenable view. If a company can market its 50-year 4 per cent. bonds at 90 per cent. of par, it means that the company's credit is on a 4½ per cent. basis; that it could market a like security paying 4½ per cent. at par. If it elects to issue at the lower rate it is merely sacrificing principal for the sake of a reduction in the annual interest charge; in other words, it is pre-paying interest which would accrue during the life of the issue. If $10,000,000 par value were issued at 90 per cent., the discount would amount to $1,000,000, and the saving in interest to $50,000 per year, or $2,500,000 in 50 years. Obviously the company cannot claim the privilege of capitalizing the discount, while thereby availing itself of the reduction in interest. If such a course were legitimate in the case of a 5 or 10 per cent. discount, it would be equally so if the discount were 50 or 75 per cent., when the absurdity of the proposition would be perfectly apparent. The somewhat general practice of prorating the discount, as a charge against revenues, over the term of the obligation's existence is sound; but this should be done, not in equal installments, but on the basis of the appreciated value of the bond as it approaches par at maturity. There is no apparent objection to charging discount of this nature in a lump sum against an accumulated surplus. The capitalization of discount on stocks, involving as it does the introduction of fictitious values in capital assets, is wholly indefensible."

The writer has failed to note any particular "judicial determination" which approves of the charge of any such item to capital account.

"(2) The interest during construction (3 per cent.) is less than a fair and reasonable return on the investment."

The amount actually paid out for interest on money used during the period of construction will vary, of course, depending on the time of construction and the way in which payments on construction materials are made. On the basis of a rate of 6% per annum and construction lasting one year, only a very small portion of the construction cost will pay 6%, while the great items of rails, buildings, motive power, and equipment will be put into the work from 90 days to 10 months after the commencement of work, and will actually bear but little interest. In the Michigan appraisal the assumption was made that all work must be replaced in one year, and that on long roads partial operation would commence as various sections of the line were completed; and 3% was agreed on as a fair average, perhaps having in mind Governor Pingree's "desire to increase railway taxation." Some assumption must be made. This one, that long roads, covering several years of construction work, are in Michigan put in partial operation as soon as built, is not unreasonable. Such an assumption clearly would not be proper in the case of long lines crossing mountains, or involving such a class of construction as to make it impossible to complete the property short of two or three years; and, in any such cases, the interest charge should be made sufficient to cover.

"(3) No allowance is made for working capital with which to carry on the business."

All the appraisals of physical property have been made on the basis of securing a figure representing the cost of reconstructing the property in the condition in which it existed on the date of the appraisal, including only items properly chargeable to capital, cost of road, and equipment. This is not such an item. The writer is of the opinion, however, that it is a proper one to determine and include in any report.

"(4) No allowance is made for wear and tear of material during the period of construction. Assuming eight years to be the life of a tie, and three years the period of construction, a substantial percentage of the period of usefulness is over before the road is in operation. The use of the rails before the track is put in proper line and surface hastens the time when they must be removed."

This deterioration is a necessary incident to any construction work. It has not been customary or usual to take account of it. To add to the amount capitalized on account of this item would be manifestly improper. The only way in which this could be cared for would be in an adjustment of the depreciation reserve when raised to cover that which takes place during the construction period. This reserve, later in the address, is objected to by Mr. Williams as improper accounting:

"(5) No allowance has been made for impact and adaptation. After the line is placed in operation, each fill will sink 1 ft. for every 10 ft. of height. The slope of cuts must be increased to prevent landslides and washouts. The ballast will pound into the roadbed, necessitating additional ballast to secure a standard cross-section."

Part of this objection is covered by the item, "Appreciation of Roadbed," discussed elsewhere. This, perhaps, is a proper item, but a comparatively small one. One of the examples cited is clearly maintenance. This objection is largely covered in the Michigan work by the contingency item.

"(6) A uniform price for earthwork was used, thus ignoring the varying character of soil and length of haul."

This is erroneous. On the Michigan appraisal prices were used for earth, loose rock, and solid rock. There is practically no classification in the Southern Peninsula of Michigan, or, in fact, on 90% of the mileage of the State. The price used was not much out of the way when considered as a fair average for the territory. The same was apparently true of other appraisals. It would not be a proper figure to use in an estimate based on 1909 prices, which are materially greater than those obtaining in 1890-1900.

"(7) A uniform price list for all materials was used, thus ignoring the source of supply and cost of delivery to point of use."

This, again, is not true. Differences were made between the Upper and Lower Peninsulas; and an exhaustive study was made of rates to different sections. It is believed that the prices adopted took all these points fully into consideration. It is true that no effort was made to use different unit prices as between counties, but, in a number of cases, differences in prices were made for different sections of the State, where either local conditions as to production of materials, or traffic rates, seemed to warrant.

"(8) No allowance was made for interference with work on account of labor troubles, condition of the weather, etc., which would vary materially in the different counties of the same state."

True. Nor is such allowance ever made in actual construction, beyond the contingency item. Such items are a frequent source of annoyance, delay, and sometimes of expense, but an expense difficult to separate and set up, and clearly belonging to contingencies.

"(9) No allowance is made for carrying charges until such time as the road was placed on a revenue basis."

True; and such item is not a part of a physical appraisal.

The foregoing nine points are classed as "among other things" open to criticism. The next two quoted paragraphs are introduced to indicate the "other things" as they appear. These are mainly non-physical or intangible elements of value, which, under the method of Professor Adams, are treated _en bloc_, and which, from their nature, it would be impossible to set out and value separately; therefore, no effort is made to answer them point by point, further than to say in general that, if there is any value attaching to these items, it was presumed to have been disclosed by the method of Professor Adams, and to suggest further that had Professors Cooley and Adams had such an advocate of intangible values ten years ago, their labors would have been lightened, as all arguments by railway officials at that time were against the use of any such elements of value in an appraisal.

"No consideration has been given to the leasehold interests.... Therefore it will be seen there remains to be determined many questions vitally affecting the value of the property without regard to its value as a 'going concern.'

"There should be no difference in the basis of arriving at the value, as a 'going concern,' of the property of a railway and any industrial establishment, nor should there be any difference in the basis of valuation for taxation [exactly what Governor Pingree maintained] or other purposes. There is common to both the value due to location, good will, etc."

While the remainder of the address in question contains no specific criticisms of methods of valuation, it does go into a discussion of sundry legal decisions; and conclusions are drawn quite at variance with those set forth elsewhere in this paper. The thing most noticeable in the entire address is the lack of a proper spirit of fairness, an apparent inability to state fully and fairly the position of the men whose views are being opposed, and an undue emphasis in quoting some public official whose views coincide for the time being with the theories which are being advocated. The fact that Mr. Williams quotes from an address of Hon. Robert H. Shields, President of the Michigan Tax Commission, a statement criticising the work of Professors Cooley and Adams, illustrates the latter point.

The statement is made again and again that the Michigan work was a physical valuation; that no attempt was made to secure a "fair value" (the language of the Courts), and that the value as a going concern was not attempted to be given. In no case is the statement made that Professor Cooley had charge of the physical valuation in Michigan, and that Professor Adams took this physical valuation, and, under his method, treated it as one element, and with it and other data derived from a study of the reports and earnings of the company, undertook to determine a "non-physical," "intangible," "franchise," or "going concern" value, which included all tangible elements, and which, added to the physical value, was assumed by Professor Adams to give the true value. Had such a statement been fairly made, no possible objection could be raised to the making of any number of points against the correctness of the methods used by Professor Adams.

"Certainly it cannot be denied that a road between New York and Chicago, 950 miles in length, passing through a manufacturing district, is of greater value than a road 1,200 miles in length, between the same cities, but passing through a hilly and undeveloped territory a portion of the distance, and through a farming section for a greater portion of the remaining distance; yet the advocates of a physical valuation would have us believe that there is no difference in the value of the two if they can be reproduced to-day at the same cost."

This statement is entirely unfair to every man who has been in responsible charge of valuation work in recent years in the United States. No theory has ever been favored by any honest-thinking advocate of a valuation. In the first place, no interstate valuations have ever been made, and no parallel case to the one assumed is to be found, except for very short sections of roads, a very marked instance having been referred to elsewhere in this paper. Such a condition as assumed would be reflected in the earnings of the companies to such an extent as to cause the non-physical element of Professor Adams as used in Michigan to correct largely or wholly the inequality and inaccuracy of the physical valuation; such at least was the theory, and, if carried to its logical end by the use of negative non-physical values, such would be the result.

The final arguments of Mr. Williams' address are devoted to an attack on the plan outlined by the Interstate Commerce Commission for valuation, and on some of the accounting methods of the Commission—points not proper to be discussed in this paper—but it is difficult indeed to read them without noting the apparently studied misrepresentation of the real attitude of Professor Adams and the Commission, and the evident object of the entire address to create a wrong impression regarding what has been done, and a prejudice against the men who have been engaged on State appraisal work and those who advocate the appraisal of properties as a proper step in the way of securing such information as will enable an intelligent consideration of the great corporation problems that must be solved.

-----

Footnote 12:

_Proceedings_, Am. Water-Works Assoc., 1902.

Footnote 13:

Commencing with the issue of January 22d, 1909.

Footnote 14:

The _Railroad Gazette_, April 19th, 1901, Vol. XXXIII. No. 16. p. 271.

Footnote 15:

_Railroad Age Gazette_, April 2d, 1909, p. 761.

Footnote 16:

_Railroad Age Gazette_, January 29th, 1909, p. 219.

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

The preceding narrative of methods of appraisal work logically leads up to the question: Will these methods that have been adopted in various appraisal undertakings stand the test of the Courts? After all, the final seal of approval must be stamped on a method by the highest Courts before it can be said to be a definitely fixed and determined principle for general use in valuation.

In a careful perusal of many papers on this subject, quotations from judicial decisions will be noted which are literally correct as far as they go, but which are incomplete and often very misleading; and often such incomplete quotations are presented as to convey an entirely wrong impression of the full decision. In order that no such charge may lie against this paper, the quotations given are full enough to indicate clearly the intent of the Court, even at the expense of undue length.

An examination of all Federal and Supreme Court cases which bear on the subject of property valuation has been made, and quotations at length from some of the older cases, establishing precedent, together with citations to more recent decisions, are submitted. It is believed that the points of principle and method, in so far as they have been determined by the highest Courts, are quite fully set forth.

A study of the complete methods of the railroad valuation in Michigan, in connection with these decisions, discloses the fact that they comply with the requirements of the earlier cases, that all matters affecting value be taken into consideration, and that in the more recent decisions the detailed methods adopted in the Cooley physical appraisal have been sustained as to very many points. In no case have any of such methods been unfavorably criticized, and, while at this date the Supreme Court has not squarely passed on the propriety of any method for securing non-physical or intangible values, it has fully sustained the general position of Professor Adams in several important points. In addition to the complete examination of Federal cases, certain very interesting and valuable State cases have been examined, and some of them are quoted.

These cases involve both matters of taxation and rate-making. They cover railroads, water-works, gas-works, and other classes of public service corporations, and clearly demonstrate the fact that any analysis of the subject of property valuations must include all classes of corporations. Rate-making and taxation in themselves are entirely separate and distinct from valuation, which is a necessary preliminary step in either undertaking. For this reason all references which are not of special interest in the valuation part of the problem are omitted.

The case of Smyth _vs._ Ames (169 U. S., 466) was an action to question the constitutionality of a statute of Nebraska establishing rates. It is of great interest, and, based on the ruling of the Court in this case, the appraiser in Washington and the appraisers in Nebraska have undertaken to secure first cost as an element of value. The decision holds that:

(1) A railroad corporation is a person within the meaning of the
fourteenth amendment.

(2) A State enactment establishing rates that will not admit the
carrier to earn such compensation as would be just to it and
to the public, would deprive such carrier of its property
and would be repugnant to the fourteenth amendment.

(3) Rates established by a State cannot be so conclusively
determined by the legislature that they cannot become the
subject of judicial inquiry.

The reasonableness of rates prescribed by a State for intra-state business must be determined without reference to the interstate business done by the carrier or the profits derived from that business.

This paper is not concerned with the question of rates, which is discussed at length in this decision. It is, however, of special interest to note what the Court says in regard to the relation of the corporations to the people, and to elements of value.

"A railroad is a public highway, and none the less so because
constructed and maintained through the agency of a corporation
deriving its existence and powers from the State. Such a corporation
was created for public purposes. It performs a function of the
State. Its authority to exercise the right of eminent domain and to
charge tolls was given primarily for the benefit of the public. It
is under governmental control, though such control must be exercised
with due regard to the constitutional guaranties for the protection
of its property.... It cannot therefore be admitted that a railroad
corporation maintaining a highway under the authority of the State
may fix its rates with a view solely to its own interests and ignore
the rights of the public. But the rights of the public would be
ignored if rates for the transportation of persons or property on a
railroad are exacted without reference to the fair value of the
property used for the public, or the fair value of the services
rendered, but in order simply that the corporation may meet
operating expenses, pay the interest on its obligations, and declare
a dividend to stockholders.

"If a railroad corporation has bonded its property for an amount
that exceeds its fair value, or if its capitalization is largely
fictitious, it 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,
and the apparent value of the property and franchises used by a
corporation, as represented by its stocks, bonds, and obligations,
is not alone to be considered when determining the rates that may
reasonably be charged."

(The Court here quotes 164 U. S., 578, Covington and Lexington Turnpike _vs._ Sanford.)

"A corporation maintaining a public highway, although it owns the
property it employs for accomplishing public objects, must be held
to have accepted its rights, privileges, and franchises subject to
the condition that the government creating it, or the government
within whose limits it conducts its business, may by legislation
protect the people against unreasonable charges for the services
rendered by it. It cannot be assumed that any railroad corporation,
accepting franchises, rights, and privileges at the hands of the
public, ever supposed that it acquired, or that it was intended to
grant to it, the power to construct and maintain a public highway
simply for its benefit, without regard to the rights of the public.
But it is equally true that the corporation performing such public
services, and the people interested in its financial affairs have
rights that may not be invaded by legislative enactment in disregard
of the fundamental guaranty for the protection of property. The
corporation may not be required to use its property for the benefit
of the public without receiving just compensation for the services
rendered by it. How such compensation may be ascertained, and what
are the necessary elements in such inquiry, will always be an
embarrassing question.

"We hold, however, that the basis of all calculations as to the
reasonableness of rates to be charged by a corporation maintaining a
highway under legislative sanction must be the fair value of the
property being used by it for the convenience of the public. And in
order to ascertain that value the original cost of construction, the
amount expended in permanent improvements, the amount and market
value of its bonds and stocks, the present as compared with the
original cost of construction, the probable earning capacity of the
property under particular rates established by the statute, the sum
required to meet operating expenses, are all matters for
consideration, and are to be given such weight as may be just and
right in each case. We do not say that there may not be other
matters to be regarded in estimating the value of the property. What
the company is entitled to ask is a fair return upon the value of
that which it employs for the public convenience. On the other hand,
what the public is entitled to demand is that no more be exacted
from it for the use of a public highway than the services rendered
by it are reasonably worth."

The body of this decision is quoted at length to show:

First. That the Court reiterates the relation of the people to
the corporation, as defined by Covington and Lexington
Turnpike Road _vs._ Sanford (164 U. S., 578) and by Stone
_vs._ Farmers' Loan and Trust Company (116 U. S., 307).

Second. That the basis for computing a fair rate is the fair
value of the property, which must be arrived at by a
computation or series of computations taking into account
many different factors.

Third. That while the Court mentions certain things that may
serve as indices of value, which are to be taken into
account and given due weight, the Court does not outline or
define any method of arriving at a value, but does recognize
it as an embarrassing question.

Fourth. That no such stress has been laid by the Court on
original cost as has been construed by some appraisers.

The principles enunciated in Smyth _vs._ Ames are reiterated by the Court in San Diego Land Company _vs._ National City (174 U. S., 739), with the further ruling:

"The contention of the appellant in the present case is that, in
ascertaining what are just rates, the Court should take into
consideration the cost of its plant; the cost per annum of operating
the plant, including interest paid on money borrowed and reasonably
necessary to be used in constructing the same; the annual
depreciation of the plant from natural causes resulting from its
use; and a fair profit to the Company over and above such charges
for its services in supplying the water to consumers, either by way
of interest on the money it has expended for the public use, or upon
some other fair and equitable basis. Undoubtedly, all these matters
ought to be taken into consideration and such weight given them,
when rates are being fixed, as under all the circumstances will be
just to the company and to the public. The basis of calculation
suggested by the appellant is, however, defective in not requiring
the real value of the property and the fair value in themselves of
the services rendered to be taken into consideration. What the
company is entitled to demand, in order that it may have just
compensation, is a fair return upon the reasonable value of the
property at the time it is being used for the public. The property
may have cost more than it ought to have cost, and its outstanding
bonds for money borrowed, and which went into the plant, may be in
excess of the real value of the property. So that it cannot be said
that the amount of such bonds should in every case control the
question of rates, although it may be an element in the inquiry as
to what is, all the circumstances considered, just to both the
company and the public."

In the case of Columbus Southern Railway _vs._ Wright (151 U. S., 479), the Court quotes approvingly from Franklin Company _vs._ Railroad (12 Lea (Tenn.), 521-537-538-539), and shows that the doctrine quoted had already been enunciated by the Supreme Court in the State Railroad Tax Cases (92 U. S., 575-607). The Court quotes as follows:

"The property of a railroad company for purposes of taxation
consists of its realty, its local personalty, its rolling stock, its
choses in action, and its franchises. The franchise is a privilege
conferred by the charter of incorporation, namely the right to
exercise all the powers granted in the mode prescribed for the
purpose of profit. It is a unit not confined to any one county in
which it may be exercised.

* * * * *

"Obviously, after ascertaining the value of the entire franchise in
the State as a unit, no more approximate or just division of this
value can be made for purposes of taxation than to allot it among
the counties through which the track runs in proportion of the
entire length of track in the county to the entire length of track
in the State....

"The roadway itself of a railroad depends for its value upon the
traffic of the company and not merely upon the narrow strip of land
appropriated for the use of the road, and the bars and cross-ties
thereon. The value of a roadway at any given time is not the
original cost, nor, _a fortiori_, its ultimate cost after years of
expenditure in repairs and improvements. On the other hand, its
value cannot be determined by ascertaining the value of the land
included in the roadway assessed at the market price of adjacent
lands, and adding the value of the cross-ties, rails, and spikes.
The value of land depends largely upon the use to which it is put
and the character of the improvements upon it."

The mileage basis of apportionment is sustained in the following and other cases:

State Railroad Tax Cases 92 U. S., 608

Delaware Railroad Tax Case 18 Wall., 206

Erie Railway _vs._ Pennsylvania 21 Wall., 492

Western Union Telegraph Company _vs._ Mass 125 U. S., 530

Pullman Palace Car Company _vs._ Pennsylvania 141 U. S., 18

Maine _vs._ Grand Trunk Railway 142 U. S., 217

Pittsburg, Cincinnati, Chicago, and St. Louis Railway 154 U. S., 430
_vs._ Backus

Therefore this basis of division of values between territorial units appears to be well established by precedent. This is in a measure unfortunate, as certain classes of property cannot be apportioned equitably in this way, unless the value of a railroad be determined, and then that value allocated between different territorial units in proportion to mileage, without any regard to the location of any structure or series of structures in any State or county, the track-mileage basis must be looked upon as a method of apportionment which is subject to modification or which will lead to error.

In an Indiana tax case, Cleveland, Cincinnati, Chicago, and St. Louis Railway _vs._ Backus (154 U. S., 444), the late Justice Brewer, of the Supreme Court, in handing down the judgment, said:

"The true value of a line of railroad is something more than an
aggregation of the values of the separate parts of it, operated
separately. It is the aggregate of those values plus that arising
from a connected operation of the whole, and each part of the road
contributes not merely the value arising from its independent
operation, but its mileage proportion of that flowing from a
continuous and connected operation of the whole.... The value of
property results from the use to which it is put, and varies with
the profitableness of that use, past, present and prospective,
actual and anticipated. There is no pecuniary value outside that
which results from such use....

"In the nature of things it is practically impossible, at least in
respect to railroad property, to divide its value and determine how
much is caused by one use to which it is put and how much by
another. Take the case before us, it is impossible to disintegrate
the value of that portion of the road within the State of Indiana
and determine how much of that value springs from its use in doing
interstate business and how much from its use in doing business
wholly within the State. An attempt to do so would be entering upon
a mere field of uncertainty and speculation."

In the Michigan cases, the principal one being Michigan Central Railroad _vs._ Powers (201 U. S., 245), the question of method of valuation was not passed on by the Courts for the reason that, after the evidence was in, and during the argument, counsel for the railroad admitted that the Cooley valuation was as correct a figure as it was possible to secure under then existing conditions, methods and rates of taxation being the issue.

It is thus seen that the Supreme Court of the United States was not, in any of the earlier cases, required to pass squarely on the propriety of any method of arriving at a "fair value," and consequently had not, prior to 1909, defined any hard-and-fast rules of procedure in determining such value. The Circuit Courts have passed on kindred questions in a few cases, among which San Diego Land and Town Company _vs._ National City (74 Fed., 83), and San Diego Land and Town Company _vs._ Jasper (110 Fed., 714) hold as above, and cite most of the cases referred to. In the latter case the Court says:

"The actual value of such property obviously depends upon a variety
of considerations—among them the actual and prospective number of
consumers—and is no more unchangeable than the value of any other
kind of property."

As an illustration, there is cited the effect of a year's drouth on an irrigation plant as temporarily affecting the value of property.

In the case of Cotting _vs._ Kansas City Stock Yards (82 Fed., 839) the Circuit Court touches on one very interesting argument, in the light of some of the methods of valuation advocated by railway managers and some of the criticisms of recent valuation work.

"Different methods of estimating the value of property may properly
be employed when it is valued for different purposes. When a
valuation is placed on property which has become affected by a
public use, for the purpose of ascertaining whether the maximum rate
of compensation fixed by law for its use is reasonable or otherwise,
it is obvious that the income derived therefrom by the owner before
it was subjected to legislative control cannot always be accepted as
a proper test of value because the compensation which the owner
charged for its use may have been excessive and unreasonable. Again,
when property has been capitalized by issuing stock, neither the
market value nor the par value of the stock can be accepted in all
cases as a proper criterion of value, because the stock may not
represent the money actually invested, and furthermore because the
property may have been capitalized mainly with reference to its
income producing capacity, on the assumption that it is ordinary
private property which the owner may use as he thinks proper without
being subject to legislative control. On the other hand, however,
when property is valued for the purpose last stated, it is clear
that the owner thereof is entitled to the benefit of any
appreciation in value above the original cost and the cost of
improvements, which is due to what may be termed natural causes. If
improvements made in the vicinity of the property, the growth of
city or town where it is located, the building of railroads, the
development of the surrounding country and other like causes, give
property an increased value, the owner cannot be deprived of such
income by legislative action which prevents him from realizing an
income commensurate with the enhanced value of his property."

The language of the late Judge Brewer, sitting as one of the circuit judges in the case of National Water-Works Company _vs._ Kansas City (62 Fed., 853), is definite as to the necessity of taking into account some elements of intangible value, and is here quoted as giving the views of this eminent jurist:

"The difficult question, however, still remains; and that is, what
is the 'fair and equitable value,' which by the statute and
ordinance the city is to pay for the water-works? * * * We are not
satisfied that either method, by itself, will show that which under
all the circumstances can be adjudged the 'fair and equitable
value.'

"Capitalization of earnings will not, because that implies
continuance of earnings, and a continuance of earnings rests upon a
franchise to operate the water-works. The original cost of
construction cannot control, for original cost and present value are
not equivalent terms. Nor would the mere cost of reproducing the
water-works plant be a fair test, because that does not take into
account the value which flows from the established connections
between the pipes and buildings of the city. * * * A complete system
of water-works, such as the company has, without a single connection
between the pipes in the streets and the buildings of the city would
be a property of much less value than the system connected as it is
with so many buildings and earning, in consequence thereof, the
money which it does earn. The fact that it is a system in operation,
not only with a capacity to supply the city but actually supplying
many buildings, in the city—not only with a capacity to earn but
actually earning—make it true that the 'fair and equitable value' is
something in excess of the cost of reproduction."

The foregoing authorities cover practically all the older cases in the 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.