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in accordance with the precedent set by Courts, authors, and legis-
latures. One of the most prominent of the authors of works on valu-
ation has recognized the difficulties attached to the multiple meanings
in the current usage of the word, but dismisses the subject with the
statement that the substitution of other terms is not without diffi-
culties.



VALUATION OF PUBLIC UTILITIES 1333

After careful consideration, the Committee has concluded that
the general use of a modified terminology would go far toward les-
sening the opportunity for misunderstanding, and therefore suggests
that the use of the word "value" be restricted in general to its ordinary
significance as defined by the Standard Dictionary: "The desirability
or worth of a thing as compared with the desirability of something
else," and has recognized the propriety of the use of other terms than
"value" to express the bases on which purchase, rate-making, or the
determination of the reasonableness of rates, capitalization, or taxation
must rest. (See Glossary under Value.)

The Committee adopts this terminology except when it is necessary
to use the terms "value" and "fair value" with the meanings attached
to them by the Courts, in which case they will be enclosed in quotation
marks.

The Committee has attempted in this report to cover the whole
subject assigned to it, which requires a very extended report, even
when it is limited to the general features of the subject. To cover
all questions which arise in connection with valuation would be im-
practicable in a report by a committee of this Society.

The following preliminary statements may assist to an under-
standing of the discussions which follow:

1. — Although the report deals with the principles and methods of
valuation, it lays stress on the fundamental principles. General
methods are indicated, but little attention is given to detailed methods
which necessarily vary under different circumstances.

2. — The discussions, unless otherwise stated, are confined to normal
properties which are neither overbuilt, inadequate, nor improperly
located.

3. — It is the view of the Committee that valuation should have its
foiuidation in fact, and that the results obtained should be those which
will be fair to the parties affected.

4. — The interdependence of methods of valuation and of regulation
of public service properties must be recognized. Different methods
of regulation may be adopted, which, taken in connection with the
appropriate methods of valuation and consistently followed, will be
fair to the parties affected. It is not, however, immaterial which of
the fair methods are adopted, because one may be more closely in
accordance with the law as defined by the Courts than another, and
hence may be more capable of being carried out effectively.

5. — Where there may be two or more practicable and lawful methods
of procedure, it is still desirable to aim toward uniformity and to select
the most approved methods for general use, as this will tend toward
simplicity and the avoidance of that confusion of thought and action
which occurs when such uniformity does not exist. The methods



1334 VALUATION OF PUBLIC UTILITIES

recommended by the Committee are those which, all things considered,
are in its judgment most desirable for general use.

6. — The various elements which enter into the valuation of a
property are frequently interdependent, and equitable results can be
obtained only by a recognition of this fact.

Y. — As indicated by the preceding paragraphs, a sharp distinction
should be made between what may be done now under present laws
and what may be done under future legislation and continuous com-
mission control. The recommendations applying to present conditions
should not be confused with those which can become practicable only
with such legislation and control.

8. — The Committee has devoted the major portion of this report
to a consideration of principles and methods which should govern in
the valuation of the physical property plus development expense, or,
in other words, what it has cost or would cost to create the property
and to create the business. The valuation so determined does not
cover all the elements of value which should receive consideration
from the Courts and the various regulating bodies; therefore, a por-
tion of the report is devoted to a discussion of intangible values and
to other matters which may in many cases have an important bearing
in the final determination of "value".

9. — Until the science of valuation and the adoption of sound
accounting methods have advanced much further than at the present
time, it is probable that different methods will have to be used in
different cases to produce fair results, and special cases will always
continue to arise which require methods adapted to them. The aim,
however, should be toward uniformity.

10. — In questions relating to valuation, interest is an important
item which should always be considered, and when interest is men-
tioned in this report it means interest compounded annually.

The valuation of public utilities has obtained special importance
in recent years, and most of the literature relating to this subject
has been issued within the last sixteen years. The principles and
methods involved are now being carefully considered by many public
service commissions and the Courts, as well as by engineers, lawyers,
and committees of various societies having to do with public utilities.
The subject is still in the developmental stage. Until recently, there
were no engineering or legal works devoted exclusively to the valuation
of public service properties, but since 1911 several important and
valuable books on this subject have been published.*

* See "Valuation of Public Service Corporations," by Robert H. Whitten,
New York, 1912 and 1914, a comprehensive work in two volumes in legal form, which
contains a discussion of the various principles involved in the valuation of the property
of public service corporations, and is replete with extended quotations from the opinions
of the Courts ; also, the following: "Valuation of Public Utility Properties," New York,
1912, and "Value for Rate-Making," New York, 1916, by Henry Floy; "Public



VALUATION OF PUBLIC UTILITIES 1335

The Committee, in preparing this report, has carefully considered
the views expressed in these recent works and in the many written
discussions on the Progress Report.

utilities. Their Cost New and Depreciation." New York, 1913, and "Public Utilities,
Their Fair Present Value and Return," New York, 1915, by Hammond V. Hayes;
"Principles of Depreciation," New York, 1915, by Earl A. Saliers ; and "Public
Utility Rates," New York, 1916, by Harry Barker.

See also Bibliography to July 16th, 1913, containing 61 pages, prepared in the
Library of the American Society of Civil Engineers, under the direction of the Secre-
tary, at the request of the Committee, Transactiojis, Am. Soc. C. E., Vol. LXXVI,
December, 1913, p. 2133. This bibliography, together with an additional 72 pages,
bringing it up to December 23d, 1915, has been published by the American Electric
Railway Association.



1336 VALUATION OF PUBLIC UTILITIES



CHAPTER II.



FUNDAMENTAL PEINCIPLES OF VALUATION.

A fundamental principle of primary importance is that a valuation
shall be made so that it will be fair to all parties affected.

So long as it is desired that public service corporations and not
government shall provide the utilities required by the public, it will
be necessary, in the exercise of public regulation, to use principles and
methods of valuation which, when properly applied, will attract the
capital necessary for building new properties, for extending old ones,
and for rendering satisfactory service.

Under normal conditions, the investor is induced to create new
property by the prospect of obtaining a fair return on the amount of
his investment*, and such investment is a fair basis for valuing such
new property, but is not necessarily the "value".

Not many years ago, it was very common to value public service
property by capitalizing the net earnings, and though the sum thus
obtained may be a proper element for consideration under some con-
ditions in the valuation of a property, it is manifestly not a proper
basis on which to predicate reasonable returns.

The fundamental principles involved in the valuation of a new
property are necessarily different in some respects from those involved
in the valuation of an old one, because a new property, which has not
begun to earn or to have the value of its parts affected by appre-
ciation or depreciation, stands in a different position from an old one
which has been in operation and earning for many years, and has
many parts which may have appreciated or depreciated in value. More-
over, in the case of an old property, valuable property or rights may
have been acquired or lost, without the payment or receipt of money
therefor, as a result of time or through the failure of the public or the
owner of the property to assert their authority. Property or rights
so gained or lost affect the valuation materially, and a failure to recog-
nize them would be inequitable to the present owners of the property
and to the public.

A more extended statement will be given of the fundamental prin-
ciples involved in the valuation for various purposes of these three
classes of property, namely:
New properties;

Old properties under commission control from their inception;
Old properties which have not been subject to continuous reg-
ulation.

* The word, as used here, is intended to mean the reasonable and proper Invest-
ment for creating the property, and not a reckless or improvident Investment.



VALUATION OF PUBLIC UTILITIES 1337

Valuation of New Properties.

If a new property, just ready for operation, is to be valued in con-
nection with the determination of fair return, then, because working
capital will be required, tmfinished work must be completed, and
development expense incurred, a reasonable and proper basis for what
the Courts have called "fair value" is the actual investment in the
property devoted to public use plus an estimated sum for working
capital, final completion, and development expense, the word "invest-
ment" being defined, as in this report, to include not only the outlay
of money but also the money value of services and other considerations
involved. Such a basis is the most rational one to use in this
connection, because a fair return on such a sum, would be a fair
return on the investment, and this is what is needed to attract capital
to such properties.

If the same property, just ready for operation, is to be valued for
public purchase or in connection with condemnation proceedings by a
public body, such as a municipality, the public purchase base of a suc-
cessfully constructed property should be the actual cost, including
the money value of services and other considerations involved.

A valuation of the same new property for capitalization should be
determined in the same way as the return base, except that all parts
of the property, whether devoted to the public use or not, should be
included.

A valuation for taxation of a public service property, whether new
or old, must accord with the laws of the State in which it is situated,
whether or not the laws are equitable, and, where not governed by
such laws, should, to make it equitable, be fixed at a sum consistent
with the valuation of other property for taxation.

Valuation of Old Properties Under Commission Control from

Their Inception.

Some of the basic principles involved in the valuation of old prop-
erties can be discussed best by taking a hypothetical case of a normal,
well-established property, operating without competition and under
commission control as to rates, methods of accoimting, etc., from its
inception. It is assumed that such a commission would have acted
throughout the life of the property in accordance with the basic prin-
ciples which should govern in such a case. Some of these are :

(a) The owner of the property is entitled to reimbursement through
the earnings for all current expenses for operating the property and
maintaining in good condition the units of which it is composed, in-
cluding the amounts paid for taxes.

(h) The owner of the property is entitled to an allowance sufficient
to provide for the net depreciation in the value of all units of physical



1338 VALUATION OF PUBLIC UTILITIES

property, whether resulting from decay, wear and tear, or other causes,
the amovmt of such depreciation allowance to be sufficient to pay for
all such property units by the time they cease to have value.

(c) The owner of the property is entitled to a fair return on a
'•'fair value" of the property, and such return should include, not only
the ordinary rate of interest for the use of well-secured capital, but
in addition a profit commensurate with the risks incidental to the
investment.

{d) If, during the early years of operation, before the property is
tuned up and the business developed, it is impracticable, as generally
is the case, to earn the current expenses (a), a suitable depreciation
allowance (6), and a fair return (c), the owner of the property should
be compensated in some way for the loss during the early years.

The first of these basic principles (a) is universally recognized.

The second (&) does not define whether the depreciation allowance
shall be annual or otherwise, but the decision of the United States
Supreme Court in the Knoxville case supports the equitable principle
that the allowance for depreciation should be earned annually and
should be of sufficient size to keep the investment intact. A portion of
the decision is as follows:

" * * * the company is entitled to earn a sufficient sum an-
nually 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."

The third basic principle (c) is applicable to normal properties and
especially to those not subject to competition, and is in accordance
with the general view which has been expressed by the United States
Supreme Court for many years, namely, that the owner of a property
is entitled to a fair return on the "fair value" of the property.

The fourth basic principle {d) can be applied in practice either by
increasing the "fair value" of the property by the sum of the de-
ficiency of earnings in the early years, with interest, or by allowing
higher rates of return in subsequent years to offset the early deficiency.
This subject is further discussed imder the head of "Development
Expense".

Valuation of Old Properties Which have not been Subject to
Continuous Eegulation.
The basic principles (a), (&), (c), and {d), given on the preceding
pages, are important in connection with old properties not subject to



VALUATION OF PUBLIC UTILITIES 1339

continuous regulation, but there is another basic principle already
referred to, relating to such property, which in many cases makes the
sum representing the sacrifice by the owner an inequitable basis of
"fair value". This is :

(e) Valuable property or rights may have been acquired or lost by
the owner of a public service property, as a result of time or through
the failure of the public or the owner to assert their authority.

A failure to recognize such property or rights in a valuation at the
present time would be unfair to the present owner or owners of the
property or to the public.

The basic principle (e) may apply to many features of an old
public service property, but two illustrations will indicate what is
intended.

Years ago, in the absence of restrictions on rates, a public service
corporation may have had very large earnings, and, after paying out
adequate di^ddends, may have had a large surplus, which it expended
in increasing and improving its property. Such action was then re-
garded as commendable. If the public for many years has neglected to
exercise its right to regulate rates, it is only just and equitable that
the increase and improvement in the property thus created should be
recognized, and that the present-day owners should not be penalized for
this neglect.

As an instance of a loss by the owner of an old property, he may
long ago have neglected to charge rates sufficient to maintain his invest-
ment intact, with a resulting diminution in the value of his property.
The public, many years afterward, could not be expected to make good
the deficiency of former years. This is the view taken by the United
States Supreme Court in the Knoxville case, where it states:

"If, however, a company failed 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 secu-
rities, 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 in management which have been committed in the past."

The foregoing discussion is based chiefly on grounds of equity, but
it is also true that the Courts recognize as a general rule that it is the
present value of property which should be used, and not its cost.

Where the sum representing the sacrifice by the owner cannot be
accepted as a basis for valuation, it is necessary to find other bases,
and a discussion of these and the fundamental principles in each
case will be found in the chapters headed "Original Cost to Date"
and "Cost of Reproduction".



1340 VALTTATTON OF PUBLIC UTILITIES



CHAPTEE III.



PHYSICAL PEOPERTY TO BE INCLUDED IN VALUATION.

The physical property to be included in valuation varies in dif-
ferent cases with the use to which the valuation is to be put and the
law governing' the case. It is desirable to cover the entire property,
placing different classes in separate schedules, so that full information
may be available to the Court or commission having the final decision
as to the property to be included.

The most important questions which arise in making schedules
are those which ask whether, and to what extent, property not devoted
to the public use, property retired from service, temporary works,
donated property, leased property, working capital, and securities
owned shall be included. Is it proper to exclude a part of the total
value of works on the ground that they have been built of a size in
excess of that required for the service? Is the title to a property a
controlling feature in determining whether or not it shall be included
in the schedule? All these questions will be discussed in this chapter.

Used and Unused Propeuty.

It is the well-established rule of the Courts that when a valuation
is made for the purpose of rate regulation, only that property is to be
included which is devoted to the public use or is used for the pub-
lic convenience. In a valuation for capitalization, it is obvious that
all the property should be included. In the case of condemnation of
a property which is taken over by the public authorities, all the prop-
erty condemned would be subject to valuation, and according to law
every element of its value should be included.

The opinion of the United States Supreme Court with regard to
the property to be included in valuation for rate regulation is shown
by the following brief quotations from decisions, covering the period
from 1898 to 1913:

"The fair value of the property being used by it for the convenience
of the public." "What the company is entitled to ask is a fair return
nn the value of that which it employs for the public convenience."
(Smyth V. Ames, 169 U. S., 466, March 7th, 1898, page 546.)

"The then value of the property actually used for the purpose of
supplying water." (Stanislaus County v. San Joaquin and King's
Eiver Canal and Irrigation Co., 192 U. S., 201, January 18th, 1904,
page 213.)

"The fair value of its property devoted to the public use." "The
value of its property actually used for the public." ("Willcox v. Con-
solidated Gas Co., 212 U. S., 19, January 4th, 1909, page 50.)



VALUATION OF PUBLIC UTILITIES 1341

"The basis of calculation is the fair value of the property used for
the convenience of the public." (Minnesota Rate Cases: Simpson
et al. V. Shepard; Same v. Kennedy; Same v. Shillaber, 230 U. S., 352,
June 9th, 1913, page 434.)

In view of these decisions, it is clear that the law does not provide
for the inclusion of imused property in a valuation for the purpose of
rate-regulation, but there must necessarily be much latitude in the de-
termination of the property to be classed as "used" and "unused''.
Although a few of the discussions by the Courts indicate a tendency
toward the exclusion of all property not "actually used", in cases of
doubt both Courts and commissions have in practice favored including-
rather than excluding property.

Clearly it is a narrow construction of the law to claim, a-
has sometimes been done, that all property not actively in use at the
time of the valuation should be excluded. A broader policy is desir-
able, both in the interests of the owner of the property and of the
public. The property considered to be devoted to the public use, and
therefore to be valued, should include, not only that in active use in
the every-day operations, but that which is properly and reasonably
held in reserve to insure the sufficiency and continuity of the service.

In general, it is not proper to apply any arbitrary rules excluding
property temporarily out of use. Railroad equipment may be stored
during periods of depression; snow-plows and flangers are in use ouIa'
a small part of the time, and thousands of other cases might be cited
of property not actually in service at the time of the appraisal, but
useful, and essential as a part of the equipment of the property. In
like manner, the duplicate pumps in a water-works, and reserve power
units of all kinds, are essential to the proper operation of the property
and necessary in times of emergency, although not actually used any
considerable proportion of the time. No rule of valuation which ex-
cluded such property could be sustained by sound reasoning, as the
very life of the service depends to a large extent on sufficient reserve
to tide over emergency or peak of business. Such property should be
included in regular schedules.

Recognizing that the erection of manufactories and other build-
ings, the opening of new streets, the laying out of parks, and the making
of other customary improvements in the neighborhood of public utili-
ties, as well as increases in the value of adjoining property, will make
the future acquisition of lands for the expanding needs of such public
utilities difficult and expensive, if not impossible, it has been cus-
tomary for public utilities to exercise foresight in the purchase of sur-
plus land at crucial points, and in the opinion of the Coromittee it is in
the interest of both the owner of the property and of the public that
such land purchased in good faith and held in reserve for future use



1342 VALUATION OF PUBLIC UTILITIES

should be included in the valuation, even though portions are for a time
not in active use.

The following extract from a decision of the New York Public
Service Commission for the Second District, in a rate case, is quoted
as an instance of what appears to be a rational treatment of the prob-
lem of determining what portion of certain lands should be included
as used property (Buffalo Gas Co. v. City of Buffalo, 3 P. S. C, N. Y.,
2 D., 553, February 4th, 1913, pages 578-579) :

"All of the land at the Genesee Street plant should be treated as in
the public service. The contention of the city that a certain parcel
next to the canal is not in the public service should not be allowed.
It is not in fact used at this moment, but it is directly adjacent to the
generating plant of the company, and with any growth in the business
would undoubtedly be needed; and justice and fair dealing do not allow
for a moment the quantity of land to be scaled down to the lowest



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