Chapter VII: Front Matter (7)

(_C_) Some of the property cost more than new articles of the
same kind at the time of inquiry. Some are of designs not
now favored by the scientific and manufacturing world.

The disputed questions involved, as far as tangible property is concerned, were:

1.—Whether the values ascribed to the several enumerated items
are based on competent and persuasive evidence.

2.—Whether the method of valuation pursued by the master is in
accordance with law.

3.—Whether the items of property are "employed" (in the legal
signification of the word) in the production of gas.

The first, a question of fact, is found affirmatively, and the evidence was found to be competent.

The second question is one of law, and, quoting from the cases cited in this paper, the Court holds as follows:

"This method of valuation correct * * * upon reason it seems clear
that in solving this equation the plus and minus quantities should
be equally considered and appreciation and depreciation treated
alike.... The value of the investment of any manufacturer, in plant,
factory, or goods, or all three, is what his possessions would sell
for upon a fair transfer from a willing vendor to a willing buyer,
and it can make no difference that such a value is affected by the
efforts of himself or others, by whim or fashion, or (what is really
the same thing) by the advance of land values in the opinion of the
buying public. It is equally immaterial that such value is affected
by difficulties of reproduction. If it be true that a pipe line
under the New York of 1907 is worth more than was a pipe line under
the city of 1827, then the owner thereof owns that value, and that
such advance arose wholly or partly from difficulties of duplication
created by the city itself is a matter of no moment. Indeed, the
causes of either appreciation or depreciation are alike unimportant
if the fact of value be conceded or proved; but that ultimate
inquiry is oftentimes so difficult that original cost, and reasons
for changes in value, become legitimate subjects of investigation as
checks upon expert estimates, or bookkeeping, inaccurate and perhaps
intentionally misleading. * * *

"The so-called money value of real or personal property is but a
conveniently short method of expressing present potential
usefulness, and 'investment' becomes meaningless if construed to
mean what the thing invested in cost generations ago. Property,
whether real or personal, is only valuable when useful. Its
usefulness commonly depends on the business purposes to which it is
or may be applied. Such business is a living thing, and may flourish
or wither, appreciate or depreciate; but, whatever happens, its
present usefulness, expressed in financial terms, must be its value.
* * * It is not to be inferred that any American government intended
when granting a franchise, not only to regulate the business
transacted thereunder, and reasonably to limit the profits thereof,
but to prevent the valuation of purely private property in the
ordinary economic manner, and the property now under consideration
is as much private property as are the belongings of any private
citizen. Nor can it be inferred that such government intended to
deny the application of economic laws to valuation of increments
earned or unearned, while insisting on the usual results thereof in
the case of equally unearned and possibly unmerited depreciation.

"I think the method of valuation applied by the report to land,
plant, mains, services, and meters lawful. To 'working capital, Coke
and Coal Company, and Astoria' the above considerations are not
applicable, and these items will be treated separately."

The Court's review of the third question raises no points of special interest as to valuation.

The question as to amount of "working capital" is taken up, and that term is defined as:

"The amount of cash necessary for the safe and convenient
transaction of a business, having regard to the owner's ordinary
outstandings both payable and receivable, the ordinary condition of
his stock, or supplies in hand, the natural risk of his business,
and the condition of his credit; and unless these matters, and
perhaps others, be looked into, no comparison can be drawn between
one business and another, or even between those of the same general
nature."

In this instance it is of interest to note that the Court reduced the "working capital" from $3,616,000 to $1,616,000.

Perhaps the most novel and interesting part of this decision is that dealing with the intangible elements of value. The master was unable to separate the two elements, good will and franchise value, but gave their combined value.

"From the testimony I think it apparent that what is here meant by
good will is the organization of complainant, long established, and
doubtless well manned and equipped. Such organization is clearly of
value, because without it neither tangible nor intangible property
can be profitably managed. Yet the organization itself is but a
method of utilizing that which is invested, it is really dependent
for its existence and continuance upon the franchise, without which
there can be no useful organization. Tangible property has a certain
value entirely apart from franchise or right to continue business,
but good will in the sense of the organization for the business of
furnishing gas, can have no existence whatever apart or detached
from the franchise conferring the necessary privilege. Would any one
think of capitalizing good will of this kind and distributing its
assumed value in the shape of new shares among stockholders new or
old? I think the most ingenious financier could not imagine such a
proceeding, and, if this good will be not property capable of such
capitalization and distribution, I do not think it property capable
of capitalization as against the State.

"Finally, this claim of good will seems to forget that for many
years the price and distribution of complainant's gas has been
regulated by law. A citizen is entitled to have a clean street
before his house because he pays taxes, _inter alia_, for that
purpose. He is much more plainly entitled to have complainant's gas
in his house because the company must give it to him if he pays for
it. I think it apparent that the conceivable good will of a gas
company in this city is about equal to that of the street-cleaning
department of the municipal government."

Is a public service corporation entitled to add the value of its franchise to the assets from which a fair return may lawfully be demanded? This question is taken up and discussed exhaustively by the Court (157 Fed., 872 to 879), and while it is clear in reading his judgment that he does not believe it sound doctrine to invest a franchise with value, yet, after citing a large number of cases, he reaches the conclusion that he is "compelled" to consider franchises, not only as property, but as productive and inherently valuable property, and to add their value, if ascertainable, to complainant's capital account before declaring the rate of return.

This case went to the Supreme Court of the United States, where, under the title Willcox _vs._ Consolidated Gas Company (212 U. S., 19), citation is made to many cases in connection with the matter of franchise value. The decision of the Court is:

"The value of real estate and plant is to a considerable extent a
matter of opinion, and the same may be said of personal estate when
not based upon the actual cost of material and construction.
Deterioration of the value of the plant, mains, and pipes is also to
some extent based upon opinion. All these matters make questions of
value somewhat uncertain."

The Supreme Court permitted the tangible values found by the lower Court to stand. It concurred with the lower Court in that it was not a case for a valuation of good will. It concurred with the lower Court in holding that the company was entitled to the benefit of any increase in tangible values, and that such increases should appear in the appraisal. It did not agree with the Court in the increase of franchise value above that which was capitalized in 1884, with the consent of the State of New York, and reduced the franchise value figure to $7,781,000. On this basis, the estimated return, under the new rate on the valuation of $55,612,435, was 5½%, which rate, in view of all the circumstances, is held to be not confiscatory and to be a not unreasonable return on the investment. The franchise value, as commented on in these cases, is referred to at considerable length in the following pages.

On January 4th, 1909, the case of Knoxville _vs._ Water Company (212 U. S., 1) was decided. This, in some respects, is of greater value to the engineer than any others cited, in its determination of methods. In this the appraisement of the tangible property was made in minute detail, the sum of $10,000 was added for "organization, promotion, etc.," and $60,000 for "going concern."

"The latter sum we understand to be an expression of the added value
of the plant as a whole over the sum of the values of its component
parts, which is attached to it because it is in active and
successful operation and earning a return. We express no opinion as
to the propriety of these two items in the valuation of the plant
for the purpose for which it was valued in this case, but leave that
question to be considered when it necessarily arises. We assume
without deciding, that these items were properly added in this case.
This valuation was determined by the master by ascertaining what it
would cost to reproduce the existing plant as a new plant. The cost
of reproduction is one way of ascertaining the present value of a
plant like that of a water company, but that test would lead to
obviously incorrect results if the cost of reproduction is not
diminished by the depreciation which has come from age and use....
The cost of reproduction is not always a fair measure of the present
value of a plant which has been in use for many years. The items
composing the plant depreciate in value from year to year in a
varying degree. Some pieces of property, like real estate for
instance, depreciate not at all, and sometimes, on the other hand,
appreciate. But the reservoirs, the mains, the service pipes,
structures upon real estate, stand-pipes, pumps, boilers, meters,
tools, and appliances of every kind begin to depreciate with more or
less rapidity from the moment of their first use. It is not easy to
fix at any given time the amount of depreciation of a plant whose
component parts are of different ages with different expectations of
life. But it is clear that some substantial allowance for
depreciation ought to have been made in this case.

"The company's original case was based upon an elaborate analysis of
the cost of construction. To arrive at the present value of the
plant large deductions were made on account of the depreciation.
This depreciation was divided into complete depreciation and
incomplete depreciation. The complete depreciation represented that
part of the original plant which through destruction or obsolescence
had actually perished as useful property. The incomplete
depreciation represented the impairment in value of the parts of the
plant which remained in existence and were continued in use. It was
urgently contended that in fixing upon the value of the plant upon
which the company was entitled to earn a reasonable return, the
amounts of complete and incomplete depreciation should be added to
the present value of the surviving parts. The Court refused to
approve this method, and we think properly refused. A water plant
with all its additions begins to depreciate in value from the moment
of its use. Before coming to the question of profit at all the
company is entitled to earn a sufficient sum annually to provide not
only for current repairs but for making good the depreciation and
replacing the parts of the property when they come to the end of
their life. The company is not bound to see its property gradually
waste, without making provision out of earnings for its replacement.
It is entitled to see that from earnings the value of the property
invested is kept unimpaired, so that at the end of any given term of
years the original investment remains as it was at the beginning. It
is not only the right of the company to make such a provision but it
is its duty to its bond and stockholders, and, in the case of a
public service corporation at least, its plain duty to the public.
If a different course were pursued the only method of providing for
replacement of property which has ceased to be useful would be the
investment of new capital and the issue of new bonds or stock....
If, however, a company fails to perform this plain duty and to exact
sufficient returns to keep the investment unimpaired, whether this
is the result of unwarranted dividends upon over issues of
securities, or of omission to exact proper prices for the output,
the fault is its own. When, therefore, a public regulation of its
prices comes under question, the true value of the property then
employed for the purpose of earning a return cannot be enhanced by a
consideration of the errors of the management which have been
committed in the past."

The Court holds that there was error in only considering the operations of the company for a period of one year, and that this should have extended to enough time to remove danger of abnormal business conditions and observe the effects of certain ordinances.

The decision of the Supreme Court, in the Omaha Water-Works case, decided on May 31st, 1910 (_Supreme Court Reporter_, July 1st, 1910), is of general interest in its discussion of the procedure of appraisers in making a water-works appraisal, and in the distinction drawn between appraisals and arbitrations; but it does not touch on appraisal methods or elements of value, except to discuss "going values." The language of Judge Lurton on this point is as follows:

"The option to purchase excluded any value on account of unexpired
franchise, but it did not limit the value to the bare bones of the
plant, its physical properties, such as its lands, its machinery,
its water-pipes or settling reservoirs, nor to what it would take to
reproduce each of its physical features. The value, in equity and
justice, must include whatever is contributed by the fact of the
connection of the items making a complete and operating plant.

"The difference between a dead plant and a live one is a real value,
and is independent of any franchise to go on, or any mere good will
as between such a plant and its customers. That kind of good will,
as suggested in Willcox _vs._ Consolidated Gas Company (212 U. S.,
19), is of little or no commercial value when the business is, as
here, a natural monopoly, with which the customer must deal, whether
he will or not. That there is a difference between even the cost of
duplication, less depreciation, of the elements making up the water
company plant and the commercial value of the business as a going
concern is evident. Such an allowance was upheld in National Water
Works Company _vs._ Kansas City (62 Fed., 853), where the opinion
was by Mr. Justice Brewer. [This decision is quoted in the foregoing
pages.] We can add nothing to the reasoning of the learned Justice,
and shall not try to. That case has been approved and followed in
Gloucester Water Supply Company _vs._ Gloucester (179 Mass., 365,
and 60 N. E., 977), and Norwich Gas and Electric Company _vs._
Norwich (76 Conn., 565). No such question was considered in
Knoxville Water Company (212 U. S., 1) or in Willcox _vs._
Consolidated Gas Company (212 U. S., 19). Both cases were rate cases
and did not concern the ascertainment of value under contracts of
sale."

The writer does not read into the language of this decision an approval of a separate element of value to be called "going concern value" or "going value" in addition to other non-physical values, but rather a recognition of the fact that certain non-physical elements of value, by whatever name they may be called, must be taken into account in arriving at the fair and equitable final figure of value of a live and operating concern for the purpose of carrying out a contract of sale.

It appears to be doubtful whether the Court can be construed as approving such an element of value in rate cases.

It thus appears that the United States Courts have laid down a few rules, which may be regarded as fixed and definite and must be followed, but that many important questions have not yet been decided. The value to be determined must be a "fair value" of the property being used for the convenience of the public. The par value of stocks and bonds may not alone be considered (although it may be considered), the market value of stocks and bonds, original cost plus cost of additions, the probable earning capacity, the cost of reproduction, depreciation, appreciation, all these, and any others that will throw light on the "fair value" must be taken into account and given the weight to which they are entitled. Any fictitious book values due to over-issues of stock and bonds are to be given no weight, but the appraisal must give the fair value, in the light of all the facts, of the property in actual use at the time of the appraisal.

There are several decisions of the State Supreme Courts which discuss these subjects, but an examination of a number of these gives practically nothing more, in the way of definite conclusions as to method, than has been cited. Perhaps the most complete and painstaking consideration of appraisal problems by any Court was that given by Judge Savage of the Supreme Court of Maine (97 Maine, 185, and 99 Maine, 371). These were neither rate cases nor taxation cases, but proceedings under statute to require from the Court instructions to a board of appraisers appointed to value the plants. In the later or Brunswick case, Judge Savage elucidates a number of points left not altogether clear in the Waterville case. The Brunswick decision contains some interesting views on "going value," and the Court's remarks on the general difficulties in making rules for an appraisement are exactly to the point:

"There are many difficulties, if not dangers, in attempting to
formulate rules which are to be applied to facts not yet
ascertained. While it may be easy enough to state rules in the
abstract, it is much more satisfactory in an opinion of the court,
to express them in terms which are applicable to the facts in the
precise case in hand.... It must be always understood that our
answers to these questions are intended to be given only in the most
general and comprehensive terms, which may, or may not, be found to
be fitted to the facts which may subsequently be developed. No other
course would be wise or safe.... A public service property may or
may not have a value independent of the amount of rates, which for
the time being may be changed. A public service company may, under
some circumstances, be required to perform its services at rates
prohibitive of a fair return to its stockholders, considering their
property as an investment merely....

"Now, what is the property which the district has taken by power of
eminent domain? In the first place it is a structure, pure and
simple, consisting of pipes, pumps, engines, land rights, and water
rights. As a structure, it has value independent of any use, or
right to use, where it is, a value probably much less than it cost,
unless it can be used where it is, that is, unless there is a right
to use it. Nevertheless, it has value as a structure. But, more than
this, it is a structure in actual use, a use remunerative to some
extent. It has customers, it is actually engaged in business, it is
a going concern. The value of the structure is enhanced by the fact
that it is used in, and in fact is essential to, a going concern
business. We speak sometimes of a going concern value as if it is,
or could be, separate and distinct from structure value—so much for
structure and so much for going concern. But this is not an accurate
statement. The going concern part of it has no existence except as a
characteristic of the structure. If no structure, no going concern.
If a structure in use, it is a structure whose value is affected by
the fact that it is in use. There is only one value. It is the value
of the structure as being used. That is all there is of it."

The Court then argues that, as the structure is being used under authority and by virtue of franchises, it is more valuable. The franchise, however, is limited; other and competing franchises may be granted; a franchise may exist entirely independent of a structure. He holds that the structure is more valuable with the franchise.

"It is a structure in actual use, and with a right on the part of
the owner to use it and to charge reasonable rates to customers for
services rendered. It is threefold in discussion but it is single in
substance."

This case is largely taken up with a discussion of the reasonableness of rates which furnish a basis for the estimate of value. There is no specific attempt to describe methods of procedure. That is left to the appraisers. These two Maine Cases, together with a valuable paper[17] thereon by Leonard Metcalf, M. Am. Soc. C. E., constitute an extremely valuable addition to the literature of appraisements.

It is clear, from a study of all the cases referred to in this paper, that the Courts have laid down a line of precedent which is equitable and just, that the interests of both public and corporations will be safeguarded, and that the likelihood of any unfair or improper valuations passing the scrutiny of the Supreme Court is but remote.

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Footnote 17:

_Transactions_, Am. Soc. C. E., Vol. LXIV, p. 1.

PHYSICAL VALUES AND METHODS FOR THEIR DETERMINATION.

All the foregoing narrative of methods adopted in recent valuations, review of judicial opinions, and comment on the expressed opinions of various engineers and railway officials, is presented as being proper and necessary to support the contention that the Michigan valuation, while not the first appraisal work, was the first valuation work of large magnitude undertaken by any State; that it was a work which established many precedents; and that the complete discussion of methods and principles in connection with and following this appraisal has given it probably a greater general value than any similar undertaking. The Wisconsin work, which immediately followed that of Michigan, was along lines similar to those of the Michigan physical valuation, and carried the work forward, adding to and strengthening certain of its features. Without any impropriety, it may be claimed that these two appraisals have laid down the general lines on which this class of engineering effort will be largely directed in the future.

It is desirable, in closing this paper, to indicate such general methods of procedure in valuation practice as may be said to have been thoroughly established by precedent, and to present such argument as will support the contention that such methods are proper.

The fact has been emphasized, again and again, by every writer on the subject, that problems of this class are not capable of exact mathematical solution; that, no matter how much care may be exercised in the execution of the work, the result is tempered by the personal judgment of the men engaged on it, and that only when it is executed by men of experience, sound judgment, and high moral worth can it have a definite, final, and just result.

This feature of appraisal work cannot be too strongly emphasized. The value of the work depends on the character of the men doing it, their experience in design, construction, and operation of properties, and their absolute fairness and freedom from prejudice.

That there will be many large valuations undertaken in the near future, there appears to be no doubt. These valuations will be made as a necessary preliminary to three classes of corporate control: rate-making, taxation, and the regulation of capitalization.

The Courts hold that the value must be "the fair value of the property used for the public," and that the corporation:

"may not impose upon the public the burden of such increased rates
as may be required for the purpose of realizing profits upon [such]
excessive valuation or fictitious capitalization." (Smyth _vs._
Ames.)

This language is repeated, again and again, so that it is clear that any valuation, to be sustained by the Courts, should:

_1._—Be based on a careful study and analysis of all the information applicable to the case in hand; and

_2._—That it must separate the various elements so that every step of the work may be reviewed and supported.

Public interest demands that, in any valuation, certain figures shall appear which shall show the amount of _bona fide_ capital actually existing in the property at the date of appraisal.

The fact that a given amount of money was invested in building a railroad in 1880, and that certain other sums were spent for additions in subsequent years, does not necessarily indicate that these amounts of capital will still be found in the property in 1910.

The removal of timber from surrounding lands, the destruction of industries and the removal of tracks leading thereto, the destruction of equipment and facilities, the depreciation in value of adjacent property, along with wear and tear, and obsolescence, have gone to effect the destruction or loss of capital on many Michigan railroads. The case in 212 U. S., 1, clearly directs that the valuation must not take into account this destroyed capital, but must return a "fair value of the property as it is."

On the other hand, the amount of money actually spent in producing a given property in the past may be far below the present value. The appreciation of value of lands by reason of development of cities and growth of industries, the increase in cost of the materials entering its construction, and many other causes, may lead to an appreciation of the value of the property, and this appreciation should appear in the valuation and the company be entitled to the benefit of it. It is in the nature of an increase of the investment, and should appear as capital.

It is clear that there are two classes of elements of value in the final value of a public service property: those which are physical, and those which are intangible. There are various of the physical elements of value which are not material or susceptible of inventory, but which, nevertheless, attach themselves to the physical property, are capable of determination, within reasonable limits of certainty, and should be taken into account and computed as physical property.

In the subsequent discussion of physical and intangible values, it is attempted to differentiate between such elements as should attach to the physical value, or capital remaining in the plant, and the purely intangible or franchise values.

It is contended by the writer:

That the Physical Value, or present value of the physical property, should fairly represent the actual capital invested in the property at the date of appraisal; that it should be made up of the sum of the various elements which constitute the cost of reproducing the property together with any appreciation which may have been added to any of them, less all depreciation.

That the Non-Physical Value is the difference between the "fair value" as defined by the Courts, or the reasonable value of the property as a business or producing property, and the physical value, or actual present worth; and that the only proper method for determining such values involves a study of income accounts.

This Non-Physical Value may be: positive, or a value in excess of the physical property, or negative, or less than the physical value. In the case of a property having a negative intangible value, a deduction should be made from the physical value.

It is further contended that, in making the physical appraisal, the purpose of the appraisal should not be permitted to modify the figures. The resultant figure should be the same, whether it is to be used as a basis for assessment, rate-making, or limitation of capitalization. It should be an engineering estimate of the amount of _bona fide_ capital still remaining in the property, or of the complete cost of reproduction under existing conditions, less depreciation. This figure is definite, within reasonable limits, and it cannot be conceded that it is permissible to vary it, submitting one result as a physical value for taxation, and another and different result as a present physical valuation for rate-making.

There may be some question as to the propriety of using non-physical values for certain ultimate ends; in fact, the Supreme Court, in the Omaha and Knoxville water cases, clearly indicates that they must not be used for certain purposes; but, in any case, to furnish information, this element of value should be determined, and, as in the case of physical values, it should be an unchangeable figure[18] and should represent the difference between the worth of the actual physical property and the final business value of the property considered as an earning proposition.

It is not necessary to go minutely into detail as to the various steps to be taken in making the appraisal of physical property. Each appraisal will offer some problems peculiar to itself, and no general set of rules can be laid down which will be applicable to all cases. It is deemed sufficient to call attention to general matters of major importance and to refer to some points which have not been mentioned in the preceding narrative, omitting argument in the case of such as have there been fully discussed.

The distinction should be kept in mind that any element of value which belongs to the property by reason of its physical existence is classed as an element of physical value. The property is considered as an operating property in the sense that it is reproduced complete, ready to operate; and any expense, or any element of value needed to complete it, is an element of the physical value, but any value arising as a result of surplus earning power, any good-will value, going-concern value, or value due to established business, strategic location, favorable traffic arrangements, etc., should be considered as intangible values.

The valuation of physical property is naturally divided into four parts:

I. —The preliminary study,

II. —The field inspection,

III. —The computation,

IV. —The preparation of the final figure.

I.—The Preliminary Study.

The preliminary steps should include a general examination of the property, a study of its corporate history, an examination of its records, maps and profiles, and the preparation of an inventory of its property.

The work in Wisconsin and Minnesota was done in co-operation with the railroad companies, who prepared (generally, but not in every case) their own inventories on forms adopted by the appraiser. In Michigan, all this information was secured by the appraiser. There can certainly be no valid objection to the use of information compiled by the companies, whose familiarity with their own records and property would enable them to supply lists which under all ordinary conditions would be more complete and up-to-date than if made up by men having no special knowledge of the property.

The chief difficulty encountered in making an inventory from recorded data lies in the fact that very few sets of records are corrected to date, and many additions and erasures will of necessity have to be made in the field.

In making a field inspection, it is of great assistance to be able to refer to maps of large yards, to profiles, to standard plans, and to drawings of the principal structures, so that the investigation of office records should include a careful examination of the maps of principal terminals, with a view to securing such as will simplify the field inspection. The investigation should be extended to cover a study, not only of the engineering office data, but also statistical data to be derived from the records of the auditor, superintendent, and superintendent of motive power, and should cover earnings, operating expenses, car and locomotive mileage, and such other data as will facilitate the distribution of such elements of value as are not localized, together with such other statistics as will furnish a thorough knowledge of the property and its operations.

It has been claimed by the appraiser in Washington—and the view is also held by the Commissioner of Railroads in Nebraska—that original cost is essential, in view of the Supreme Court's decision, particularly in Smyth _vs._ Ames. The writer cannot accept the correctness of this position. It would appear that the language of the Court should be construed to mean that original cost, where ascertainable, is a proper matter to take into account, along with many other things; but it can hardly be considered mandatory.

In the case of a property only recently built, in which the records are complete and the engineering and construction files are available, it may not be specially difficult to determine cost, but in the case of any of the large railway systems of the United States, which are made up of the consolidation of many different roads, some of them built many years ago, some of them having gone through many changes of management, reorganization, and earlier consolidation, it is practically impossible to secure either the old financial books or the old construction records, and without these complete records it would appear to be an utter impossibility to secure the primary cost. Primary cost is but the first step. The work of building up, by securing the amount of additions and betterments that have been made from year to year, is one of appalling magnitude and of utter uncertainty and conjecture. Keeping in mind that, prior to July 1st, 1907, the railroad companies of the country did not have a system of uniform accounting, and that additions to property were charged to operating expenses to the extent of hundreds of millions of dollars; that policies were different on different roads, and under different managements of the same road, and that the accounting methods were determined by the policy of the road or management; and the further fact that the distribution of ordinary railroad accounts may be extremely reliable on one road and abounding with errors on another; it will be seen that any attempt to depend on the auditor's office for anything approximating a complete statement of cost would lead into a maze of figures which would be confusing, unreliable, and incapable of proof.

Therefore, it is the writer's conclusion that, beyond such figures on recent construction, or records of cost of such special structures as are matters of particular record, it is not advisable to attempt to secure complete data as to the cost to date of a railroad. In the Michigan appraisal, original cost was secured in the case of many structures, notably the Port Huron Tunnel, and it is by no means argued that original cost should not be considered, or investigated, but it is held that such an undertaking as to secure, from the financial books of the company, an accurate or reliable statement of construction cost, plus additions and betterments, less property destroyed, of the Michigan Central Railroad, for example, would be absolutely an impossibility, particularly if the work was to be undertaken, as in the Washington appraisal, by men who were utter strangers to the property. The admission of the appraiser of Washington, that, except for a few gaps, the information was complete, is fatal, as the gaps must needs be filled by estimates, and it would appear to be better to depend on estimated figures throughout than to use what purported to be actual costs on part and estimates on the remainder.

If original cost is essential, it is hard to get away from accepting the book values of the companies, as these, objectionable as they may be, from the viewpoint of the public, are just as apt to be as near the actual truth as any statement made up by strangers from an examination of old records covering many years of operation.

II.—The Field Inspection.

The field inspection, to be of the greatest value, should be made by civil or mechanical engineers of long experience, preferably by men who have had charge of their respective departments on railroads of considerable extent, or of properties similar to that under investigation. The writer is of the opinion that in this particular phase of the work, the practice adopted in the Michigan appraisal was considerably in advance of more recent valuations. Each particular structure or piece of equipment should be examined and its condition noted; special features should be fully described and careful record made of everything that would tend to affect the value. The argument has been often made that the fixing of a percentage of depreciation by a man in the field is purely arbitrary and amounts to nothing but a guess. In the computing office it is often necessary to check the field figure of depreciation by the use of tables of fixed annual depreciation, but it must be borne in mind that mortality tables of any form are based on a system of averages. The actual depreciation on rail, for instance, varies greatly; the conditions of traffic, curvature, gradient, rolling stock, and various local conditions tend to shorten or lengthen the life, so that the personal opinion of an experienced man on the ground is likely to be much more nearly correct than the arbitrary application of a rule of averages.

The writer has inspected station buildings more than 50 years old, and their condition and adaptability for the service required of them would give them a very high percentage; he is also familiar with buildings less than 10 years old, which, by reason of changed traffic conditions and consequent shifting of business, have become obsolete and have been permitted to depreciate so rapidly that any table average would give too high a result.

In the case of a water-works inspection, so much of the value is included in the system of distribution mains, a form of property which is inaccessible, that much more dependence must be placed on a figure based on age; but there, also, as full investigation as possible should be made, in order to determine to what extent tuberculation or electrolysis has affected the pipes.

A general inspection (made in Minnesota by the appraiser with two assistants) would appear to be an excellent thing as a review of the whole work, but whether such an inspection would be sufficiently thorough to base thereon a set of final values, would appear to be doubtful.

The inspection in the field, in addition to the placing of a percentage for depreciation, should involve a complete check of the inventory, a correction of all errors, due to the construction of new property or the destruction or removal of old, and a compilation of all information required for a complete, correct, and intelligent appraisal of the physical property by the computing office. Every appraisal is different, and every property offers new problems and diverse conditions. These must be met, and therefore the field inspector must call particular attention to all matters specially affecting the values of the property he is inspecting.

It is impossible to anticipate all these conditions in advance, although the use of carefully prepared blanks and the standardizing of the form in which the data are gathered greatly simplify the work, not only in the office, but in the field.

III. The Computation.

On the completion of the field work, with all the preliminary data in the office, the computation must proceed, and with this part of the work there are many questions which must be taken up, considered, and definitely answered.

The classification and arrangement of the information as to the property to be valued, the costs and prices of the various materials entering into construction, the making and checking of such tables as may be required for estimating, the computing, checking, filing, indexing, and the various other routine details of work need not be referred to specially, as they must be worked out for each appraisal. The matters of principle that will be met are more important, and, while it would be impossible to mention all that may come up, it may not be amiss to refer to a few.

(_a_) In making an appraisal of several properties, to what extent shall these properties be grouped or classified?

(_b_) What unit prices shall be assigned in the estimates of cost of reproduction, and how shall they be determined?

(_c_) How shall right-of-way and real estate values be ascertained? Shall such elements as appreciation, or any increments due to the purpose for which the land is used, be treated as physical or non-physical values?

(_d_) What method shall be finally adopted in determining depreciation? What elements shall depreciation be made to cover?

(_e_) What elements of cost or appreciation shall be treated as parts of the physical property although not capable of inventory, and what shall be treated as non-physical?

(_f_) Is an allowance for contingencies a proper item to include in an appraisal?

(_g_) What weight shall be given the matters of adaptability, proper or improper design, and the economics of location?

(_h_) How shall the values of such property as locomotives, cars, etc., be geographically assigned?

(_i_) What is the effect upon values of large terminals?

(_j_) Should an allowance be made by reason of rapid development of the art?

These are not by any means all the perplexing questions that arise; each valuation offers some that are special, but these cover the more important points.

(_a_) _Classification of Properties._—In making an appraisal involving the properties of a large number of companies, such for instance as any of the State railroad appraisals, it becomes evident that there are certain properties which are small, badly run down, and either built to serve a very limited trade or located in a territory which has not developed, and that such properties cannot be compared equitably with the large trunk-line roads, or even with smaller roads in a good territory and doing a good business. Several such properties exist in Michigan in a district which was originally a lumber-producing country, and at the time they were built local conditions were such that prices of timber and labor were far below any cost that it would be reasonable to assume to-day. Whether taxation or rate-making be the ultimate end of the work, it is certain that these carriers are entitled to some classification which will separate them from the more prosperous roads. Many of these roads would not be built to-day under any circumstances, yet their maintenance and continued operation is absolutely essential to the people of the district served by them.

Whether this classification should be undertaken at the time of making the appraisal of physical property, and an attempt be made to classify unit prices, or whether this should be taken up in connection with the intangible values, and solved, as far as the valuation is concerned, by the adoption of such a method as will affect these physical values by a subtractive or negative non-physical value, or whether the entire matter should be left for the subsequent work of rate-making or assessment, is one which must be determined at the outset of the physical valuation. It may not be left without determination, as the question will be raised in all probability in the form of an attack on the valuation, if it is not considered and a conclusion reached.

It is the writer's opinion that the application of an intangible subtractive value is the proper solution, except in the case of roads which would not to-day be rebuilt. In fixing a uniform price for identically the same labor or material, whether on a small poverty-stricken road or a main trunk line, no serious injustice is done, provided the price fixed is one which, from a strictly engineering standpoint, is a reasonable figure for cost of reproduction. The differences in class are due, not to special differences in cost of physical property, but rather to differences in earning ability on account of good or poor territory served, efficient or inefficient management, or other reasons not connected with the physical structure; hence such differences are reflected in the earnings, and are clearly elements to be adjusted in the non-physical valuation.

(_b_) _Unit Values._—The general reliability of the appraisal rests very largely on the reasonableness and fairness of the various prices which are applied to the different parts of the property in making the estimate of cost of reproduction. These unit prices should be determined before any actual figures are made. They should be made up from the most complete data available, and, before being tabulated, should be carefully reviewed by all the experienced men engaged on the appraisal, in order that no figure which is either too high or too low may be used.

As a basis, the average of either 5 or 10 years should be used in preference to current prices on all such material and equipment as is fairly stable. Rail, and all forms of rail structures, machinery, locomotives, cars, etc., can be reduced to such a unit that averages can be secured which will eliminate the error due to a period of extreme high or low prices.

In the case of such materials as lumber and ties, the price of which has been steadily rising, due to the growing scarcity of the material, a price based upon a long average is unfair to the corporation, and it would appear to be proper to use current prices. There can be no hard-and-fast rule which will be applicable to all appraisals. The unit prices must be such reasonable figures as can be sustained in Court. Their adoption should not be final until every possible test of their accuracy and reasonableness has been made. When they have been adopted, and such modification made as may be fair for certain territory, on account of local conditions, transportation facilities, or other consideration which may affect them, the adopted figures should be applied to all property alike. The use of different unit figures for different roads in the same territory is highly undesirable, and should be avoided.

(_c_) _Right of Way and Real Estate._—The valuation work which has been accomplished during the past decade, and the study of values for taxation and rate-making, have brought into prominence the perplexing features of land values as applied to corporation property. It is comparatively simple to fix within very close limits the reproduction cost of tracks, bridges, locomotives, or any of the other elements of physical structure. Not so with the land. A few years' development may change farm land right of way into city right of way, surrounded by factories, or it may change desirable residential property adjacent to a road into slums.

In view of the clear language of the Court in 82 Fed., 839, and 157 Fed., 849, it is evident that any valuation which does not take into account the appreciation or depreciation of land values cannot be sustained. There can be no serious objection to the doctrine that the property of a corporation generally increases or decreases in value in the same proportion as adjacent property, and it must therefore be admitted that a value based on the sale value of adjacent lands is a reasonable one and must stand. This reasoning, of course, will be subject to exceptions, in the case of terminal properties, docks and water-front properties, and right of way in large cities, but it is believed to be sound when applied to right of way in the country and in small towns and cities.

The next question to be determined is whether the increment of value due to the use of the land is a proper one. It would appear that in the use of land for water-works, gas-works, street-car barns, or other isolated tracts of land used for corporation purposes, this increment would be much less than in the case of a steam or interurban railroad, the holdings of which form a continuous and unbroken strip; and, in the case of street railroads, water-works, and like properties, it would be indeed difficult to compute and afterward sustain any considerable increment.

In the case of railway properties, however, it is quite evident that the following facts can be sustained: The actual cost of property purchased for railway purposes will range from two and one-half to five times the selling price of similar and adjacent property used for other purposes. While the actual percentage will vary somewhat, as between land in cities and in the country, and as between fully settled districts well served by roads and sparsely populated regions, yet the difference is very marked, and is capable of determination by an examination of the public records.

This difference can be determined either by a comparison of railway purchases and other transfers, as was done in the later studies in Michigan and in Wisconsin, or by extending the investigation to include assessed valuations, and using the averages, as was done in the work of Mr. Morgan in Minnesota.

In establishing figures for use in a valuation, it would appear to be better to base them on an analysis of actual transfers than to undertake to fix values by any methods of examination and personal appraisal. Enough instances of the wide divergence of expert opinion have been cited to show conclusively that such a method, applied to the thousands of acres of a large corporation, may lead to serious error.

A single attorney or real estate man who has had experience in abstracting and conveyancing, and who has bought some right of way, can examine the records of an average county the largest city in which has a population of 20,000 or less, abstract all railway transfers for 5 years, locate them on the maps, secure data as to actual selling prices of near-by lands, and, in a comparatively short time, be in position to furnish figures which will establish the relation between sales for railway and other purposes in that county. The work that half a dozen such men could do in 90 days would go very far toward establishing with a fair degree of definiteness the value of the railway purpose increment for the majority of counties in any average State. Of course, such an investigation in the large cities is a matter of much greater labor, and would require sufficient time to make complete examinations, probably necessitating a special force for such city work.

On every appraisal, the question has been asked, should this railway purpose increment be added to the value of the property? Clearly, yes.

The Supreme Court quotes approvingly from the Tennessee Court, as follows (151 U. S., 479):

"The value of the land depends largely upon the use to which it is
put and the character of the improvements upon it."

This is stated again and again. It must be remembered that, for railroad uses, the strip must be continuous; that it must be located so as to permit curves and grades which conform to the requirements of the road; that, no matter what damages may accrue to adjacent property, the road must take its strip; that its use is entirely changed and is a structure placed on it which is capable of vastly greater earnings than the property produced before—all these elements add to the cost of the property when it is acquired for railway purposes, and in the same measure to its value under its new use.

In a new country, where transportation facilities are limited and land cheap, this added increment may be little or nothing, but in a thickly settled State, with many railroads, this element will increase with a good degree of uniformity; while, in terminals, the price rises to almost inconceivable figures. It is capable of being determined, and is clearly an element in the cost of reproduction. The writer holds to the view that it is properly to be placed with the physical values, and that it should not be considered as an intangible element of value.

(_d_) _Depreciation._—Thus far, this discussion has not dealt at length with the subject of depreciation, and it is not considered essential to the purposes of this paper that it be done. The State appraisals have raised a question as to the propriety of using mortality or life tables as compared with personal inspection and the placing of a percentage based on individual judgment. Either method is subject to error. It is certainly desirable to secure the opinion of the man who inspects a bridge, or building, or locomotive, as to its physical condition. It may be desirable to use the check secured by the fact that the age of the building is known and also the average life of structures of its class.