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

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In the case of the Monongahela Navigation Co., a very old property
was at bar, and evidently "great consideration was granted to long-
accepted rates unaffected by regulation, on one hand, and, on the
other, to the property rights growing up from these rates on the "inno-
cent owner" idea. In general, the Courts have laid down no rale for
fixing reasonableness of rates in these cases, nor for eomputirig the
v:due of a franchise.

Considering the money value of a franchise: as a license to do busi-
ness, its value is vital, and cannot be measured in money; it is com-
parable to the value of the air v.-e breathe; as a grant to use
public property, it may carry with it costs, rent, fees, or ohligations,
the cost of which can be estimated. Such costs can hardly be called
intangible, and should certainly be included in an inventory. Such a
grant may also lessen the expense of installation which v/ould be
necessary if streets, etc., could not be used by the utility. This acts



VALUATION OF I'QBLIC UTILITIES 1519

to reduce the necessary investment. The third possible feature of a
franchise, protection from competition, is the one that has probably
given the principal money value to franchises in the past. It is the
legal base for the monopolistic rights uf corporations, and is the fea-
ture that calls for public regulation more than any other. Intangible
values acquired under this phase of franchise have been recognized by
the highest Courts to be the inalienable property of the present owners,
as shown above, but, unless such values have been converted into
physical property useful to the utility, the Courts are now very chary
about admitting them to capitalization, as may be seen by the second
quotation from the Kennebec Water District case given above. In
fact, the principles of fundamental equities would seem to prohibit
earning on intangible capital which is admittedly derived from
anticipated earnings in excess of a fair return.

In fixing upon the "fair value" for a property, the license feature
of a franchise can hardly be included; neither can the privilege to
use jiublic property, except so far as such privilege costs the grantee
money. In fact, the grant is made purposely to lessen the otherwise
necessary capital, and it would certainly be absurd to augment the
capital by assuming an intangible value for the grant. The monopo-
listic feature is then the only base for intangible value pertaining to
a franchise; and this cannot be computed separately from that arising
from "going value" which Avill be discussed in the next section.

Going Yalue — Going Concern Value.

In very many discussions and Court opinions, this component of
value has been hopelessly and blindly mixed with development expense,
which latter the Committee has set up as a distinct feature. Clearness
of understanding- will be enhanced if the separation is adhered to.

Development expense is equivalent to expenditure of capital. Going
value, on the other hand, is, in the minds of many, apparently, an
indefinite something that a live business has, which a plant without
business has not. The fact that a business is connected with its
customers, house connections made in a water supply system, the
breath of life put into the body, as some express it, seems to have an
almost mystic significance to many. It has been called the soul of
the enterprise, while the physical plant is the material body.

In the work of Henry Floy, entitled '^Valuation of Public Utility
Properties", 1912, the subject is discussed under four heads, at page
137 and following. These conceptions briefly and clearly set forth
the different methods tliat have been adopted for discussing going
value in rational terms and for measuring it in money.

They are:

First.— "A legal and economic, recognized value, usually deter-
mined in an approximate way, in addition to, and over and above the



1520 VALUATION OF PUBLIC UTILITIES

value of the physical plant, resulting from the putting of said plant
into actual and useful operation. The value may be based on merely
an actual expenditure in dollars, or an estimated value indicating the
worth of the service performed, in transforming the 'dead' into a 'live*
income producing property."

Second. — "A very frequent use of the term 'going value' is that of
'capitalized losses', namely, the capitalization of losses incurred during
the first few years after a corporation begins business."

Third. — "Going value has also been used to mean the value that
obtains from capitalizing the present net earnings of a corporation,
i. e., the value of a created income."

Fourth. — "Although the trend of modern movement is toward the
reduction rather than the creation of non-physical values, going values
have been allowed, particularly in water-works appraisals, based on
the present worth of estimated earnings including those of future
business growth.

"The method consists in estimating the present worth of excess
earnings of an existing plant compared with those of a hypothetical
plant, between the date of valuation and the time the earnings of the
assumed plant shall equal those of the existing plant."

These four interpretations cover the ideas that have been rather
vaguely expressed by Courts, commissions, authors, and others, perhaps
as well as they can be covered.

It will be seen that the first, second, and fourth are really founded
wholly or in part on a conception of what the Committee has classed
as development expense; and that the third is the "exchange value"
of this report.

A careful reading of Court decisions, attorney's briefs, and opinions
of engineers and authors on this subject, leads to the impression that
lawyers and judges have generally leaned toward an appreciation of
the intangible nature of going value as something inherent in a
"system in successful operation and earning a revenue", while engi-
neers and authors generally are disposed to look upon it as the cost
of developing, not only the capacity to earn, but the market for the
output as well.

Mr. Justice Brewer, National Water Co. v. Kansas City (62 Fed.,
853, July 2, 1894), said:

"The fact that it is a system in operation, not only with a capacity
to supply the city, but actually supplying many buildings in the city
— not only with a capacity to earn but actually earning — makes it
true that 'the fair and equitable value' is something in excess of the
cost of reproduction."

On the other hand, Mr. Benezette Williams, in connection with the
Dubuque Water-Works appraisal said, regarding the valuation of the
Kansas City Water- Works, after describing the appraisal of the
physical property:



VALUATION OF PUBLIC UTILITIES 1521

"The commissioners, however, took into account the fact that
the plant was in actual operation, with an established business and
a long list of patrons, and added to the cost of replacement, which
included a liberal allowance for contingencies, an allowance for interest
on the investment for a time long enough to enable the business to
reach the point at which it was found."

These two quotations typify the difference of conception that exists
between many students of this subject. The first implies that the
judge's conception of the amount to be allowed above reproduction
cost was of an intangible nature, presumably to be determined by a
study of the income. The other, representing more generally the
engineer's view, based this addition on what the Committee considers
tangible grounds of interest dui'ing construction and development ex-
pense. The Committee aims to clarify the subject by assigning all
costs like those referred to in Floy's first class, as above, to the appro-
priate items of the reproduction schedule, and by classing the costs
and losses of the development period as development expense and con-
fining going value strictly to its intangible aspect, depending on a
study of the income account which reflects the advantages accruing
from enlarged business, social growth, and other factors of improve-
ment and progress. Floy's third class does not exactly define the
Committee's idea, because it means the whole exchange value of the
property, while the Committee considers going value to be a sum
that may be, under some circumstances, added to the appraisal of the
physical property. It is the difference between the exchange and
physical values, and includes and is the resultant of the intangible
values pertaining to all the features discussed in this chapter. No
division is possible between the value of franchise, favorable location,
good-will, or the other elements of advantage. Their effects automati-
cally add together to make up what is distinctly going value.

If, from the actual net earnings for a given year available for dis-
tribution there is subtracted a fair return on the reproduction cost,
including therein all proper overhead charges, development expenses,
and other tangible capital items, including appreciation in value, less
"depreciation of valuation", the remainder will be a measure of the
income from going value for that year. Whether or not such income
may be capitalized and added to reproduction cost is debatable. If the
remainder, thus obtained, is not zero, its algebraic sign will determine
whether the going value is positive or negative in the case under review.

Going value derived from large earnings is legitimate and inevi-
table in competitive utilities, like the steam railroads of this country,
steamship lines, and most manufacturing enterprises, the favorable
location and good management of which give them advantage over
rivals less favorably conditioned. In competitive enterprises the



I.J'^^ VAl.rATIOX OF PUBLIC UTTLITIKS

favorably located and well managed one will naturally and properly
receive a higher rate of return on its cost than the other one.

When several properties are to be combined in a single corporation,
tlieir exchange values seem to furnish the principal basis for adjusting
rhe financial ratios between them.

Good Will.

This feature is defined as follows in the Glossary :

"In ordinary business, the good will represents the special value
that a business has by reason of its popularity and the amount of bus-
iness thereby attracted. It is a part of the value of a 'going concern'."

As applied to a department store or to professional practice, good-
will is a large item of intangible value. In some kinds of competing
utilities it undoubtedly has weight. Its effect in any case merges into
the resultant described in the last section, and the conditions accruing
among competitive utilities are the same with this as with going value.
In monopolies the highest Court has decided that good will is not an
element to be considered independently in the valuation. In the case
of Willcox V. Consolidated Gas Co. (212 TJ. S., 19, January 4, 1909),
Mr. Justice Peckham said:

''We are also of the opinion that it is not a case for a valuation
of 'good will'. The master combined the franchise value with that
of good will, and estimated the total value at $20 000 000.

"The complainant has a monopoly in fact, and a consumer must
take gas from it or go without. He will resort to the 'old stand' because
he cannot get gas anywhere else. The Court below excluded that item,
and we concur in that action."

Efficiency — Favorable Business Arrangements — Design.

These features are important, and, together with good management,
should be encouraged. They add largely to the intangible value of
a property; being, in fact, a major factor in going value which has
been discussed above.

It is often said that efficient, economical management is not encour-
aged by regulation; but this should not be the necessary result. The
English method of gas company regulation called the "London Sliding
Scale" is perhaps the most prominent attempt to encourage efficiency
that has yet been tried. It was adopted in 1904 by a Legislative act of
the State of Massachusetts in an arrangement with the Boston Con-
solidated Gas Co. At that time the price per thousand feet of gas
was fixed at 90 cents, and the dividend to the stockholders of the com-
pany at 7%, and the provision made that if in any year the price was
reduced below 90 cents the rate of dividend for the succeeding year
might be raised one-fifth of 1% for each cent of reduction below 90
cents. Provision was made in the Act for creating a surplus fund,
If the earnings were not entirely exhausted by the dividends allowed,



VAJ.UATIOX OF PUBLIC UTILITIES 1523

and for increasing the price to consumers, if necessary in tlie judgment
of the Gas and Electric Light Commission. The Act, following
English precedent, provides that additional stock may be issued with
the approval of the commission, but such issue shall be sold at public
sale under competitive bids; also that the standard price, the scale,
and the dividend rate shall be subject to readjustment after ten years
from the passage of the Act. At present (1916) the price of gas
under this arrangement is SO cents and the dividend rate 9 per cent.
The regulating board has radical changes in the method of control
under consideration. In England the scheme has been in operation
for thirty years or more, and does not work with entire satisfaction,
except for a limited number of years after its adoption. In some cases
the companies have not increased dividends as the scale allows them
to do, evidently on account of the possibility of competition from other
producers. This shows that natural competition, left free to act, is
tlie real regulator where competition may exist.

Though the group of factors named in the caption of this section
adds greatly to the exchange or market value of a property, they cannot
in general be separately included in an inventory of either original
or reproduction cost; but where exceptional efficiency in design, con-
struction, and management is" manifest, its results, although intangible,
should be recognized and encouraged by the regulating body.

Leases — Easements — Water Eights — Traffic and Operating Agree-
ments — Strategic Location and Advantages — and Other
Privileges.

These are often elements of substantial value. They are entitled
to careful analysis and consideration in accord with their just dues.
They are in the nature, however, of special problems, often highly
complex and legal in character, varying greatly with locality, environ-
)nent, and attendant circumstances. Therefore they will not be dis-
cussed in detail herein.

Conclusion.

With reference to intangible value as a whole, the Committee takes
the ground that, in finding original or reproduction cost, there must
be included first, the tangihle elements (including development expense)
to which cost can be assigned or which can be separately scheduled,
with an attached value based on concrete facts; and, second, that
pertinent facts, bearing upon the intangible values, should thereafter
[lO developed independently, as fin aid to the formation of sound judg-
ment as to their value.

Exceptional efficiency — although practically difficult of recognition
and compensation in any plan of valuation, and outside of strict
engineering analysis — .should be recognized by Courts and commissions,
when appraising property.



1524 VALUATION OF PUBLIC UTILITIES



GLOSSARY.
Accouating Cost.

See Booh or Accounting Cost, under Cost — Investment.

Accounting— Depreciation.

See Depreciation Accounting.

Accounting— Methods of.

See Depreciation Accounting.

Actual Cost.

See Original Cost, under Cost — Investment.

Additions.

Structures, facilities, equipment, and other property units added to
those in service and not taking the place of any property for like
purposes.

See also Betterments.

Age.

Under Expectation of Life — Life Term.

Amortization Fund.

See Sinking Fund.

Amortize.

To extinguish a liability or debt by means of a sinking fund. The
word, however, is frequently used in connection with such extinguish-
ment by other means.

Annuity.

An annual allowance or payment; generally an equal sum each
year, such as the payment to a sinking fund.

Appreciation.

A general definition is gain in value or worth. As used in con-
nection with the valuation of public service property, this term is gen-
erally restricted to physical items, and measures their gain in value
due to age, use, and properly directed labor. Its principal application
in connection with railroads is to roadbed, which, for instance, is in-
creased in value by solidification and grassing of slopes.

The appreciation in land values will be called an increment.

Average, Weiglited.

See Weighted Average.
Betterments.

Physical changes in roadway, structures, facilities, or equipment,
the object of which is to make the properties affected more useful,
efficient, or safe, or of greater capacity.



VALUATION OF PUBLIC UTILITIES 1525

Book or Accounting Cost.

Under Cost — Investment.
Capital.

"A portion of wealth which is set aside for the production of addi-
tional wealth.

"While this is the sense in which the word 'capital' is used in
economics, in bookkeeping the term 'capital account' is often used to
mean assets on the credit or passive side which denote proprietorship."*

Working Capital. — The capital in the form of cash, stock on hand,
and other current assets, which must be kept available for the opera-
tion, maintenance and administration of a property.

Capitalization Base.

Under Value.

Charges.

See Overhead Charges.

Cliarter.

A grant of power by the proper authority to a group of individuals
to become a corporation, in order that they may act as a unit for a
specific purpose.
Compound-Interest Method.

See under Depreciation Accounting.

Construction Period.

That part of the production or reproduction period extending from
the inception of an undertaking to the completion of its construction
and the beginning of its regular operation. The definition may apply
either to a whole property, or to substantial parts of it constructed
at different times.

This period is followed by the physical development period, in
which are incurred construction costs necessary to bring the physical
property to .its present operating efficiency. (See Reproduction
Period.)

Cost.

Cost -Investment. — In the case of a new public service property, in
which nothing has been added or abandoned, the outlay incurred in
creating the property, not only money outlay, but also the money value
of services rendered and of other considerations involved.

In the case of old properties to which many additions have been
made, and wherein many items of property have been worn out and
replaced one or more times, either in kind or otherwise, these words,
when not qualified, have no generally accepted meaning, and have been
used by the Courts, commissions, and others in a very loose way.

* From "The Accountancy of Investment", by Charles E. Sprague.



1526 VALUATION OF PUBLIC UTLlvITIES

The words are frequently qualified, as, for instance, original cost.
actual cost, original cost to date, original cost plus improvements, but
even these qualified terms appear to have no generally accepted
meaning.

Booh or Accounting Cost. — The cost as shown by the books. This
necessarily depends on the method of bookkeeping used. It is fre-
quently the case that book cost fails to include the value of services
rendered in promotion and construction, for which no money payment
was made, and such costs as those due to additions and betterments,
interest on capital during construction, and the bringing of the
property to its full present condition of operating efficiency, which
may have been paid for, out of earnings or otherwise, but properly
belong in the capital account. On the other hand, it may include
charges for replacements which do not properly belong to the capital
account, and may continue to include investment in property which
has been retired without being credited on the books.

CoKi. of Reproduction — Reproduction Cost — Replacement Cost —
Cost of Duplication. — The estimated cost of reproducing the property
without deduction for the loss of value due to age or other causes.

Original Cost — Original Cost to Date — Original Cost Plus Im-
provements — Actual Cost. — These terms are often used interchange-
ably, though suggesting different things. The Committee believes that
'"original cost to date" and "actual cost" are the better terms and
defines them as the cost of the original construction, plus all charges
against capital proper, under approved accounting principles, for ex-
penditures incurred thereafter, and minus all proper credits to capital
for the cost of property which has been disposed of or otherwise retired.

Under this definition the "original cost to date" or "actual cost"
of a property is the first cost of the identical property units now
in use, including overhead charges. The former is a term used in the
Federal Valuation Act, and may be authoritatively defined by thf
Interstate Commerce Commission.

Cost of Reproduction.

Under Cost — Invkst.m ent.

Current Repairs.

See Repaiks.

Decrement.

See Depreciation.

Decrepitude.

Decretion.

Under Depkeci.vtion.



VALUATION OF PUBLIC UTILITIES 1527

Deferred Maintenance.

A technical term used in connection with public service properties,
representing the amount which must be expended in repairs and
renewals to bring plant units to an operating condition normal for the
character of service to which they are devoted.

Depletion.

Under Depreciation.

Depreciated Value.

See Remaining or Depreciated Value, under Vaixe.

Depreciation.

A general definition is lowering in value or worth. As used in con-
nection with the valuation of public service property, it is the loss of
value due to age and use, including the loss from deterioration, wear
and tear, inadequacy, obsolescence, depletion, and other similar causes.

Discussion of depreciation generally includes, also, causes of los?
of value or worth, and methods of depreciation accounting and of re-
storing the loss to the property or its owners.

The depreciation in land values will be called a decrement.

Accrued Depreciation. — Depreciation which has taken place. It
may have reference to existing property only, or it may include also
the abandoned property.

Decrepitude. — A term sometimes used in connection with public
service properties as having a meaning similar to deterioration.

Decreiion. — Loss of service life.

Deferred Maintenance. — See Deferred Maintenance.

Depletion. — Permanent loss of value due to exhaustion, or perma-
nent lessening of value; as, for example, of mining properties.

Depreciation of Valuation or Fair Depreciation. — The sum which
should be deducted from original cost to date or from estimated cost
of reproduction new, as a step in finding that which the courts have
called "fair value".

Deterioration. — Eeduction in the quality of a property unit or in
its efficiency for service, due to its physical condition.

Fair Depreciation. — See Depreciation of Valuation, supra.

Functional Depreciation. — Depreciation due to inadequacy, obsoles-
cence, and supersession.

Inadequacy . — The insufficiency of a unit to perform fully the func-
tion required of it.

Obsolescence. — The condition or process by which units gradually
cease to be useful or profitable as a part of the property, on account
of changed conditions.

Physical Depreciation. — Depreciation due to deterioration, such
as use. wear and tear, accident.



1528 VALUATION OP PUBLIC UTILITIES

Supersession. — The substitution of a more profitable or efficient
unit for the existing property unit.

Wear and Tear.— The physical deterioration of a property unit
occasioned by its use.

Depreciation Accounting.

The branch of accounting by which loss of value is provided for
or accounted for either wholly or in part. There are various methods,
among which are:

1. — Beplacement Method. — This method makes provision from the
earnings for reimbursement for the cost, less salvage, of property
units retired when they reach the ends of their service lives, whether
for replacement or for any other reasons.

2. — Sinhing-Fund Method. — This method makes provision from the
earnings for equal annual depreciation allowances of such size for any
property unit that if these allowances are invested in a sinking
fund they will, with accumulations of interest compounded annually,
amount to the cost, less salvage, of the unit at the time when it reaches



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