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Transactions of the American Society of Civil Engineers (Volume 81) online

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the interest cost. Some additional compensation is needed for the
investment made by him during the progress of the work and which
is necessarily idle until the completion of the plant. Should the
company itself construct the plant and be able to arrange to do the
entire work on credit — gathering the material, machines and equip-
ment, labor and everything additional needed on credit, to be paid
for at the completion of the plant, at the point of operation — the
interest cost would nevertheless enter in some form in the entire cost
of construction."

It has been the practice on many valuations to assume a period of
construction, and to assume that the interest during the period of
construction would equal the interest for the entire period on one-half
the total cost. In making the assumption as to a proper period of time
in which any property could be constructed in connection with the re-
production estimate, due consideration should be given to the actual
history of the development of the property, and to the sequence in which
the various parts of the property were built or would be built under
present-day methods, and making use of existing facilities. Allowances
for interest and other overhead charges should be based on actual
experience in the construction of the property under investigation,
or similar new properties, as far as possible, and not on any such
general assumption as stated, as such assurnption is likely to give
results which would be too small in many instances and excessive
in others, and the attempt should be to determine a figure which will
be just and equitable in each case.

Some of the earlier railroad appraisals assumed that the property
would be produced in short sections, each taking one year for con-
struction, and that an allowance of 3% on the entire cost, or an
average of one-half year's interest, would be ample.

While it is undoubtedly true that some properties have been built
and opened to traffic in short sections, and have thus carried a small
interest charge, and some of these properties would be so built if they
were to be reproduced, such an assumption is not applicable to all
properties.

From the viewpoint of reproduction under present conditions, in-
terest during construction should be based on carefully prepared con-
struction and financial programmes which will provide for a proper
period for reproduction, giving due regard to the history of the enter-
prise and to the periods of times required for the construction of dif-
ferent portions of the property, as well as a reasonable sequence in
the order of reproduction, and will provide fully for all economies.
The financial programme should be so adequate as to provide ample
funds and materials, as needed during construction, and to eliminate



1440 VALUATION OF PUBLIC UTILITIES

delays. The rate of interest should be based, not on the financial credit
of the property at the time of appraisal, but on the assumption that the
property is a new property, and will be developed during the repro-
duction period assumed, and giving due weight to the hazards at-
tached to each property.

From a strictly historic point of view, the time for which interest
during construction should be allowed should be determined on the
basis of historic conditions, in the same way as other items entering
into the estimate of cost, except that normal present conditions should
be used in fixing the rate or rates of interest to be used. Due regard
should be given the history of the property as to its effect upon the
credit of the company, having in mind that in some existing utilities
large parts have been built piecemeal after the original property had
been fully established, without the degree of risk and hazard attending
the building of the original property, and that in some other utilities
the risks attending the development of the additions were fully as
great as those attending the construction of the original property. The
financial programme should be so adequate as to provide such ample
fimds and materials as would be needed during the construction periods
of the different parts of the property to eliminate delays.

It is not intended by the above statement to suggest that it is
necessary to obtain the history of each item added to the original
property or used to replace an item which has reached the end of its
life, because this would be impracticable and unnecessary; but that
the historical basis should be used as a guiding factor in determin-
ing the period for which the interest during construction of such items
or classes of items should be computed. In other words, the interest
during construction allowance for items added to a property from
time to time after the original construction should extend only over
the period of time required to build each particular item and put it in
operation, with a reasonable addition to provide for procuring the
money in advance of the beginning of construction.

Interest should then be computed on the various parts of the prop-
erty, taking into account the time required to construct each and the
total time that must elapse from the completion of that part until the
operating units of property reach the point of revenue-producing
operation.

(h) — Taxes. — The money paid out for taxes on lands, buildings,
materials, and equipment during the period of construction of a utility
property would seem to be so obviously a proper charge to capital
invested in plant as to require no supporting argument, yet it has not
received the unqualified endorsement of the Courts. An illustration
may be cited in the case of an electric light and power company in a
large mid- western city. The rapid growth of the city and increase of
the business necessitated very large increase in the plant facilities, and



VALUATIOX OF PUBLIC UTILITIES 1441

it was determined to build a new power station in a new location. A
tract of 22 acres was acquired in 1911, and work was at once com-
menced on preparation of plans. Actual construction was begun in
the spring of 1912, and the plant was put in operation during the
summer of 1915. During this period 3 full years taxes on the land
were paid, and the increase each year in the assessments, on account
of the improvements, resulted in a payment during the period of more
than four times the tax that would have been paid on the basis of the
assessed valuation at the time of purchase. This expense is unavoid-
able; it is, like interest, a charge that must be provided for, and met
out of fimds raised for construction. The percentage of the total
construction cost may vary on different kinds of property, and care
must be taken to make sufficiently full investigations to insure the
accuracy of the estimate. The Committee believes that an allowance
for taxes, in proper amount, is a fair charge to construction, and should
always be included in the reproduction estimate.

(i) — Contingencies. — Contingencies in construction are those added
costs or added items of construction which are made necessary by
unforeseen difficulties, or events beyond the control of the builders, or
are due to conditions which were not fully determined at the inception
of the work. Similarly, the contingencies in an estimate of reproduc-
tion are those due to conditions which could not be fully determined
at the time of making such estimate of cost and such conditions
always prevail, in greater or less degree, depending upon the character
of the property and local conditions, the age of the property, the
available records, and many other factors.

Contingencies vary in amount with different kinds of property and
with different property units. On classes of work in which the con-
tingency item is likely to be large, the proper percentage to allow for
contingencies will depend largely on the extent and accuracy of the
investigation.

Perhaps no one item of overhead charges on past appraisals has
drawn more criticism, and in some instances ridicule, than the allow-
ance for contingencies. The Committee, at the outset of its discussion
of the subject, desires to state that no allowance for contingencies is
advocated that is not a reasonable one.

It must be emphasized that the allowance for contingencies is an
allowance for the unseen and indeterminate cost in reproduction which
could not be seen, investigated, and determined in advance of original
construction, or at the date of valuation. Many people appear to be
unable to realize the fact that it is not possible to see all the things
that were done and know all the conditions that accompanied the doing
of them when investigating an existing great public utility.

It is fully as difficult to estimate correctly the cost of reproducing
an existing property as it is to estimate the cost of producing one



1442 VALUATION OF PUBLIC UTILITIES

which does not exist, and it may be more difficult. To illustrate,
assume one of the large hydro-electric developments or water-
works reservoirs. The property is, let us say, 12 or 15 years old.
The valuation engineer finds a massive masonry dam, some build-
ings and equipment capable of definite measurements, and a large
lake or water covering several himdred acres. All roads, railroads, and
other property surrounding the reservoir are in good condition,
and their appearance would not indicate whether they were 12 or 40
years old. The plans, field notebooks, and construction records may
be complete, but are more likely not to have been fully preserved, as in
many properties the value of old notes and construction records has
not been recognized. The problem is to estimate the cost of repro-
ducing the property. There will be many costs which can be covered
only by a contingency allowance.

The construction engineer, about to enter upon the construction of
such a property, finds in the valley to be occupied all the various prop-
erties and constructions that are to be removed, he has available the
results of explorations, surveys, soundings, borings, and other investi-
gations which will determine what will be encountered. He has equal
knowledge with the valuation engineer as to costs of material, labor,
transportation, tools and equipment, and other things needed, and his
facilities for accurate estimating are just as good. Yet, in producing
the property, he encounters costs not foreseen, due to weather, floods,
labor troubles, transportation difficulties, delays, and many other causes.

The contingencies cannot be listed in advance — otherwise they would
not be contingencies.

Those who ridicule or omit contingent allowances, or argue that they
apply to individual items rather than to the plant costs as a whole,
ignore general construction experience. The allowance for contin-
gencies is not an allowance to cover error, as has often been assumed.
To some extent contingencies in both construction and reproduction
are due to failure to schedule completely all work to be done, but, to
a far greater extent, contingencies are due to those unseen, unavoidable,
and uncontrollable causes that neither engineer, nor owner, nor con-
tractor can foresee.

Errors of judgment may occasionally add to the cost of construc-
tion, and the Committee is of the opinion that a provision for this is
justifiable.

The Committee endorses no allowance for contingencies which will
add arbitrarily a percentage to a thing that is known and definite; but
it does contend for an allowance in all cases except those in which it is
certainly known that contingencies would not be incurred.

Character of Contingency Expenses. — Omissions from Schedule. — In
both construction and reproduction estimates on large properties, where
many thousands of items of property are scattered over a wide area.



VALUATION OF PUBLIC UTILITIES 1443

or, as in the case of railroads, over hundreds of miles of territory, there
are certain to be omissions, not only of minor items, but of large items
of property. This applies, not only to property which is capable of easy
identification, but to a greater extent to that which was built in con-
nection with the construction, and was essential to it, but which is not
in constant use, and of which ownership consequently is finally lost
sight of.

Hidden Construction. — Unless the most complete records are avail-
able, much of the expense which adds to the cost of foundations of all
kinds is apt to be overlooked. Pumping or coffer-dams in some localities,
and quicksand or other treacherous material often increasing the size
or depth of foundations, makes the cost not only greater per unit but
adds largely to actual quantities in excess of the plans. Costs incident
to settlement of the surface on marshes, causing a large increase in
the fill required, are sometimes included in contingencies, but should
be allowed for preferably in the schedule of quantities.

Losses Due to Flood, Storm, or Bad Weather. — Frequent and
unavoidable expenses are those due to storms, floods, slides, and
wash-outs. There is also the added expense due to freezing or wet
weather. The examples of this class are very numerous; hardly any
large property has been built which has not had to contend with such
difficulties. *

Strikes, Labor Troubles, Delays in Delivery of Materials. — Labor
troubles are a frequent and expensive occurrence, and, at times, not
only delay completion, but add materially to the cost. The non-
delivery of material, often necessitating the purchase of small quan-
tities at high prices, or causing expensive delays, is another class of
contingency expense which is continually met. Delays are often caused
by injunction, or other legal processes or failure to raise the necessary
funds as needed, causing, not only extra expense on the work, but
loss of interest. The failure of contractors or the abandonment of
work by them, is often a serious cause of contingent expense.

Moreover, it often happens on large works that the losses due to
interruption of or delay in construction are largely augmented by
the loss in efficiency of the working force, incident to building up a
partly new organization upon the continuation of construction. The
suspension of active work upon the construction of the Los Angeles
aqueduct, due to temporary lack of funds, is stated in the report to
have caused an additional expense of $250 000.

Construction Outside of the Main Property. — In nearly all large
properties it will be found that, either owing to the special location
or conditions, or on account of relations with the public or other
owners, it is frequently necessary to build considerable work which is
in no wise a part of the property under investigation, but is required
to readjust existing conditions to permit the work to proceed.



1444 VALUATION OF PU 151.10 UTILITIES

Illustrative Examples of Actual Contingencies. — In building an
electric road near Toledo, Ohio, contracts for grading were let at 22
cents per cu. yd. for earth. One section involved a crossing under a
railroad. The presence of quicksand and water in the cut made ordi-
nary methods of handling material ineffective, and the contractor
failed. The work was completed on the basis of cost plus a percentage,
at a cost of 84 cents per cu. yd.

In 1895 the Ann Arbor Railroad was raising an embankment over
a swamp. A "sink hole" developed which broke under a freight train.
causing not only a loss of many thousands of yards of earth, but
damages to property of more than $25 000.

In March, 1905, the flood conditions in Ohio and Indiana were
unusually severe. An electric railway bridge over the Maumee Eiver
was under construction, and seven high concrete piers were completed
ready for superstructure. An ice gorge formed about 2 miles above
the bridge, and when it broke two piers were swept away, involving
a contingency expense of more than 15% of the entire cost of the
bridge.

The Cleveland Railway, in the construction of a new car-house, lost
the entire structure in a tornado after more than 70% of the work
had been completed.

Elliot Holbrook, M. Am. Soc C. E., cites examples of contin-
gencies, as follows:

"A piece of construction with which the writer was concerned con-
sumed over two years in construction, while it was expected it would
be completed in one season. The result was that owing to increased
outlay and greater length of construction period, interest alone was
increased by an amount equal to 5 per cent, of the original estimate
of total construction cost. A steel bridge near Anoka, estimated to
cost $21 000, actually cost $32 000, on account of floods taking the
coffer-dam out. Pipe line at Dassel, Minn., estimated to cost $6 600,
actually cost $8 300, owing to delays that carried the work into winter,
necessitating excavation in frozen ground. Bank widenings in Dakota,
estimated to cost $15 000, actually cost $27 000, owing to excessive
rains. Change of line from Teton, Mont., to Tunis, Mont., estimated
to cost $10 500, actually cost $33 000, on account of a hill giving way
and burying a steam shovel. A change of grade, estimated to cost
$7 100, actually cost $12 000, owing to slides and wet conditions of
material. New yard at Blair, Mont., estimated to cost $41 500, cost
$66 700, owing to heavy storms washing out grading and causing
delay. Drainage tunnel at Alvin, estimated to cost $16 700, actually
cost $23 000, on account of trouble encountered with water. In fact,
in the construction of a railroad, there is almost a continuous succes-
sion of unforeseen and imforeseeable difficulties that increase the time
necessary for construction and the total outlay required."

In the case of subway construction now under way in the City
of New York the provision originally made for contingencies, 5%,



VALUATION OF PUBLIC UTILITIES 1415

has been foimd to be inadequate, and additional elements of cost have
so far developed to indicate that they will amount to upward of 14%,
exclusive of the provision that may have to be made for contractor's
claims, and further charges for interest on money diiring construction
caused by the non-synchronizing of completed portions of the system.

Many other examples have been cited to the Committee. It is
believed that, if it were possible to separate from the bare cost of nearly
all large works those items that were actually contingencies, the list
might be greatly lengthened. Attention should be directed specially to
the fact that nearly all available cost records give total actual con-
struction, but do not give original estimates or originally estimated
quantities. To determine contingencies therefor, it is necessary to go
in most cases to the original records and make special analyses. This
will account for the comparatively small number of cases in which this
item of overhead charges has actually been segregated.

The close estimation of cost is an art, of which comparatively few
men are masters. In its final analysis it is a matter of judgment,
founded upon knowledge and breadth of experience in engineering
construction, and discrimination in the determination of the relative
eflfect of different conditions and factors entering into the problem,
as well as in the application of well kept records of previously built
works. Synthetic cost analysis has some advantages, if limited to the
main and readily determinable cost influencing items, though it has
the grave danger of implying a degree of accuracy in the results
obtained, not actually realized, and the tendency to minimize and
under-estimate the elements of hazard and uncertainty, which always
exist to a greater or less degree, on any large construction work.
Direct comparison with costs of other works, of similar character,
under similar conditions, when possible, furnishes the most reliable
guide. The method of always comparing the cost of different classes
of work, on broad lines, with a previously determined "average-scale",
based on general experience under more or less similar conditions, and
getting the coefficient or factor, as compared with the average-scale,
of each work, is most helpful, particularly to the young engineer.

Allen Hazen, M. Am . Soc. C. E., has discussed this subject in an
admirable article on "The Art of Making Eapid and Reliable Pre-
liminary Estimates of Cost",* from which the following paragraphs
have been abstracted.

Extra Cost of Novel Designs. — Work on novel designs commonly
costs more than work following standard designs. This is true even
when well tried methods are first introduced in new places. Such work
may be too small to attract bidders from a distance. The unit cost
will then overrun anticipated prices. An under-estimate of cost is



* Engineering Contracting, March 18th, 1914.



1446 VALUATION OF PUBLIC UTILITIES

frequently made on work because the estimator fails to realize what
a great effect familiarity with the methods of performing work has
upon the cost. To realize this one has but to think of the difference
between present methods and costs of building timnels and subways
and deep foundations, and the methods and costs of only 10 or 20
years ago. 'Not only is the risk which the contractor takes now less,
but methods which have been thoroughly tried out are at his disposal
as well as experienced foremen and laborers, to do the work more
economically. For a structure of new or novel design much caution
in using prices that may be standard on other kinds of work must
be used.

Small Jobs Cost more in Proportion than Large Ones. — Another
common cause of imder-estimating costs is the use of figures on large
pieces of work for estimating small work. The engineer often over-
looks the large cost of overhead charges, the waste of labor and the
cost of plant caused by organizing a force to perform a small piece
of work. He too often forgets that for small work the work must be
done by less efficient methods, or the cost of plant prohibits the use
of expensive machines. Perhaps the most common case of such under-
estimating is where the job, although a large one in the aggregate, con-
sists of many small pieces of work of widely varied character. Such
a job is troublesome and costly for the contractor, and the experienced
man knows it and puts in a corresponding bid.

It must be remembered that bids follow the law of supply and
demand; that general slackness in construction work calls out bidders
and low prices. The condition of the money market, the cost of
materials, and the general opinion of the condition of contract work
are of course matters of much importance. It seems scarcely necessary
to say that the engineer should know where and how the contractor
is to obtain his materials and have a fairly definite idea of the cost,
either in dollars and cents or as a comparative figure to other work.

The engineer in estimating should try to look at the work from the
standpoint of the contractor, should try to remember that no work
runs as smoothly along as the contractor wishes, that labor conditions
and other matters often spoil the best laid plans. He should endeavor
to keep in mind the various work he has watched or performed and the
numerous times when unexpected conditions added largely to the cost.

Generally speaking, estimates on proposed work by men of limited
experience are too low, yet it is not luiusual for an engineer to be so
impressed with the difficulty of a piece of work that he over-estimates
the actual cost, and it is more common to find that he has over-estimated
the bids of the contractors.

It is of much value to have two methods of arriving at estimates.
If an independent check method can be made, even though a rough



VALUATION OF PUBLIC UTILITIES 1447

one, a failure of the two results to agree often leads to the discovery
of serious errors in the application of one or the other method.

Conditions of Success in Estimating. — One of the first requisites
for successful estimating is a fair and unprejudiced, and moderately
pessimistic mind. The estimator must be alert for new and cheaper
processes and methods, and conservatively sceptical concerning their
merits. Moreover a successful estimator must have had experience in
actual construction. As a general rule an engineer should not make an
estimate for a structure that he would not know how to build.

Next, as a requisite to successful estimating, may be mentioned a
broad basis of cost records of actual work, more or less similar to that
for which estimates are to be made. A good and safe method of using
the cost data and adjusting it for application to new conditions is
equally important.



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