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

Report Re-committed ,;.»^f, . ^:^[. 1330

Discussion of Progress Report 1 330

Valuation only an Element in Rate Regulation 1331

- Value " and " Fair Value '' 1332

General Statements Preliminary to Detailed Discussion 1333

Valuation Literature 1334

Chapter II. — Fundamental Principles of Valuation 1336

New Properties 1 337

Old Properties under Commission Control for Their Inception .1337
Old Properties Which have not been subject to Continuous
Regulation 1338

Chapter III. — Physical Property to be Included in Val-
uation 1340

Used and Unused Property 1340

Retired or Discarded Property 1345

Excessive Size or Capacity 1347

Donated Property 1349

Leased Property 1.349

Title to Property not Conclusive 1350

Working Capital 1353

Securities Owned 1363

Chapter IV. — Original Cost to Date 1354

Definition 1354

Difficulty in Obtaining Original Cost to Date 1355

Schedule 1356

Costs— Unit Costs 1356

Overhead Charges 1357

Development Expense 1358

Chapter V. — Cost of Reproduction 1359

The Theory of Reproduction : 1359

Different Applications of Reproduction in Past Practice. . .1.359

Difficulties to be Met in Formulating a Theory. 1362

Shall Present or Original Physical Conditions Govern ?. . . . 1363
Conclusions as to Conditions to be Adojited 1370



1314 VALUATION OF PUBLIC UTILITIES

PAGK

Shall Present or Original Prices Govern ? 1370

Conclusion as to Prices to be Adopted 1372

Shall Identical or Substitute Plant be Considered ? 1373

What is Meant by the Word " New ", in the Phrase " Cost

of Keproduction New " ? 1375

Conclusion as to the Proper Conception of Reproduction. .1377
Work Preliminary to the Making of the Estimate of Repro-
duction Cost : 1377

The Schedule 1377

Classification of Property 1377

Field Schedules 1378

Use of Records 1378

Additional Information Not in Official Records 1378

No Specific Assumptions as to Difficulties where not Capa-
ble of Proof 1379

The Field Inspection 1380

Forms for Field and Office Record 1380

Unit Prices on Physical Property Other than Land : 1380

Contractors Profit 1381

Shall Average Prices or Prices as of a Certain Date be

Used ? 1382

Piecemeal Construction 1384

What Should be Included as Elements of Cost in the Unit

Prices ? 1385

The Cost of Purchasing 1385

House Service or Material Yard Service 1386

Transportation 1386

Waste, Loss and Breakage, or Overplus Over Measurements. 1386

Direct Supervision. — Inspection 1387

Illustrations of Actual Cost Affecting the Cost per Unit. . .1.388

Illustrations of Earthwork Unit Costs 1390

Conclusions as to Unit Prices 1393

The Cost of Reproducing Land Holdings : 1394

Lands not All of Similar Character. — Classes of Land 1394

Single or Detached Parcels of Land 1395

Tracts of Land 1396

Connected Strips or Bodies of Land 1397

The Term, "Just Compensation" as Defined by the

Courts 1398

Same Elements Must be Considered in Valuation as in

Fixing " Just Compensation " 1399

Comparison of Actual Costs per Acre May be Misleading . . 1399



VALUATION OF PUBLIC UTILITIES 1315

PAGE.

Market Value of Adjacent Lands, per Acre, Not Always

Conclusive 1400

The Minnesota Rate Case Decision 1401

Conclusions to be Drawn from the Minnesota Rate Case.. .1405

The Meaning of the Term, " Market Value " 1407

Value to Owner and Taker. — The Element That Must be

Excluded in Valuation 1409

Normal Cost of Public Utility Lands as Compared with

General Land Values 1411

Costs of Acquisition. — -To What Extent Includable in

Valuation ? 1418

Conclusions. — -Cost of Reproducing Land Holdings 1426

Overhead Charges: 1427

General Nature of Overhead Charges 1427

Recognition of Overhead Charges by Courts and Com-
missions 1428

Auxiliary or Collateral Costs 1431

Character of the Items Classed as Overhead Charges 1431

The Cost of Promotion 1431

The Cost of Financing 1433

The Cost of Organization 1435

Engineering 1435

Administration 1437

Legal Expense 1437

Interest During Construction 1437

Taxes 1440

Contingencies 1441

Character of Contingency Expenses. — Omissions from

Schedule 1442

Hidden Construction 1443

Losses Due to Flood, Storm, or Bad Weather 1443

Strikes, Labor Troubles, Delays in Delivery of Materials. .1443

Construction Outside of the Main Property 1443

Illustrative Examples of Actual Contingencies 1444

Chapter VI. — Depreciation and Appreciation 1448

Depreciation in Valuation 1448

Three Aspects 1453

Decretion 1453

Causes of Decretion 1453

Decretion always Present in a Going Property 1455

The Troublesome Problem 1455



1316 VALUATION" OF PUBLIC UTILITIES

PAGE.

Accountinfi Depreciation 14.")5

General Statement 1455

Fundamental Principles 1456

Classification of Property Units 1457

The Replacement Method 1459

Depreciation Reserve vs. Depreciation Fund 1460

Depreciation Theories 1462

The Straight-Line Theory 1463

The Compound-Interest Theory 1463

The Unit-Cost Theory 14(;5

Methods of Accounting Applicable to the Straight-Line and

Compound-Interest Theories of Depreciation 1467

Accounting under the Straight-Line Theory 1467

Accounting under the Compound-Interest Theory . . . .1469

Accounting under the Sinking-Fund Theory 1470

Comparison of Four Methods 1476

(a) — Compared to Bond Payments 1476

(&)_0n a Basis of Cost 1476

(c) — With Respect to Legality and Safety 1480

Rate on Depreciation Allowances 1482

Accounting Depreciation, the Result 1482

Summary 1483

Tlie Depreciation of Valuation, or Fair Depreciation 1485

Cost of Decretion 1485

1. — Treatment of Inadequacy and Obsolescence 1485

2. — Mortality Tables to be Used with Care 1490

Depreciation of Overhead General Expense 1491

Depreciation of Valuation Affected by Accounting Methods. 1492

(a) — Replacement Method . 1493

(5) — Allowance Method 1494

Effect of Investing Allowances in the Property 1495

I^ffect of Regulation on Depreciation of Valuation 1495

Concluding Suggestions 1497

Appreciation 1498

Definition and Application 1498

General Principles 1498

Determination and Estimation of Appreciation 1499

Adaptation 1501

Chapter VII. — Development Expense 1503

Nature of Development Expense 1503

Development Expense as a Part of Original Cost 1504

Losing Venture 1''504

Amortization v. Capital Charge 1505

Difficulties 1505



VALUATION OF PUBLIC UTILITIES 1317

PAGE.

Development Expense as a Part of Reproduction Cost 1507

Attitude of Courts and Commissions 1507

Going Value (Development Expense) Defined 1508

Conclusions 1510

Chapter VIII. — Intangible Value 1512

Meaning of " Intangible " as Used in Valuation 1512

Value, Tangible and Intangible Bases 1512

Exchange Value 1514

Fair Value 1514

Franchise 1516

Various Functions 1516

Court Decisions 1516

Going Value — Going Concern Value 1519

Good Will 1522

Efficiency — Favorable Business Arrangements — Design 1522

Leases — Easements — Water Rights — Traffic and Operating
Agreements — Strategic Location and Advantages — and

Other Privileges 1523

Conclusion 1523

Glossary 1524

Appendix I. — Depreciation Tables, Based on Compound-Inter-
est Method 1540

Appendix II. — Some Examples of the Expectation of Life of

So-called Permanent Structures 1567

Appendix III. — Some Examples of Actual Overhead Costs. . . . 1562
Appendix IV.— Some Records of Abandoned Water-Works

Property 1582

Discussion 1584



1318 VALUATION OF PUBLIC UTILITIES



ABSTEACT OF REPORT.

The Committee, in its consideration of the subject assigned to it,
has been guided by the belief that stress should be laid on fimdamental
principles and on general methods rather than on details which neces-
sarily vary under different circumstances; that the discussions, unless
otherwise stated, should be confined to normal properties; that valua-
tion should have its foundation in fact ; that where there are alternative
methods equally fair to the parties affected, the one should be selected
which is most capable of being carried out effectively under present
laws, as defined by the Courts, and which is most desirable for general
use in the direction of uniformity; that recognition should be given
to the interdependence of the various elements which enter into the
problem; that while major attention should be given to the ascertain-
ment of the cost of creating the property in question and its business,
due consideration should be given to intangible values, and that the
important item of interest, in this report meaning interest compounded
annually, should always be considered.

In the light of this preliminary understanding and of the discus-
sions which ensued, the following conclusions have been reached.

Fundamental Principles of Valuation.

The principles and methods must be such that when properly
applied the result will be fair to all parties affected and of a nature
that will attract to the service of the public capital necessary for
building new properties and for improving and extending old ones.

New Properties. — In the valuation of a new property, if the question
of a fair return is at stake, the actual investment in the portion
devoted to public use, including working capital and development
expense, should be taken as the basis for ''fair value"; if the same
property just ready for operation is to be valued for public acquisition,
the basis of "fair value" should be the actual cost, including the money
value of services and other considerations involved; if the valuation
is to be used for capitalization, the result should be attained in the
same way as the return base, except that all parts of the property
should be included; and if for taxation, whether of a new or old
property, the result must accord with the laws of the State, or, 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.

Old Properties Under Continuous Regulation. — In the valuation
of an old property, operating without competition and from its incep-
tion under commission control as to rates and methods of accounting,
and assumed to have been entitled to earn sums sufficiently large to
provide for all expenses of maintenance, operation and taxation, depre-
ciation allowances, and a fair return on the "fair value" of the prop-



VALUATION OF PUBLIC UTILITIES 1319

«rty, the owner should be compensated in some way for losses that
he may have sustained during the early years of operation before the
property was tuned up and the business developed, either by including
in the valuation the sum of the deficiency of earnings in the early years,
with interest, or by allowing higher rates of return in subsequent
years to oflfset the early deficiency.

Old Properties Not Under Continuous Regulation. — In the valua-
tion of an old property which has not been subject to continuous
regulation, not only are the foregoing principles important, but there
are many cases in which equity calls for the inclusion of not only the
sum representing the sacrifice by the owner but also a further positive
or negative sum representing valuable property or rights which may
have been acquired or lost by the owner as a result of time or through
the failure of the public or the owner to assert their authority, the
Courts holding that the present value of the property should be
used rather than its cost.

Physical Property to be Included in Valuation.

This varies in different cases with the use to which the valuation
is to be put and the law governing the case.

Used and Unused Property. — In cases of rate regulation, only the
property considered to be devoted to public use should be included,
embracing that which is in active use and also that which is properly
and reasonably held in reserve to insure the safety, economy, suffi-
ciency, and continuity of service. In valuations for capitalization
and public acquisition it is obvious that all of the property in question
should be included.

Retired or Discarded Property. — Plant units which have been
definitely abandoned and are not likely again to be used, due to
having been worn out in service or by reason of the reconstruction of
the property, should be excluded from the valuation and should appear
either in a separate schedule of retired or discarded property, or such
full statement of the conditions should be made as will definitely
fix the status of the units or parts. Temporary works necessarily built
in connection with, or required for, the construction of permanent
works, or for furnishing service to the public at an earlier date than
it could be furnished by the permanent works, should be included
in the valuation.

Excessive Size or Capacity. — No reduction should be made in the
valuation on account of excessive size or capacity, except when the
excess is so great as to be clearly unreasonable and is the result of
not using proper foresight.

Donated Property. — Lands or other property voluntarily donated
to a public utility should be included when determining the reproduc-
tion cost, on the same basis as land and property otherwise acquired.



1320 VALUATION OF PUBLIC UTILITIES

Leased Property. — In the case of leased property, either the prop-
erty itself or the lease should be valued, as circumstances may dictate.

Title to Property Not Conclusive. — Structures located on land
to which the owner of a public utility has no title should be included
in the valuation of the property where the owner has been required
by law or necessity to pay their cost, including in this class also
property voluntarily donated; and they should be excluded where other
public service companies, the public, or the users, other than the owner
in question, have been required by law or necessity to pay their cost.

WorJcing Capital. — It is customary to include under the term
"working capital" the amount of cash, materials, and supplies, provided
for use in the plant, but not yet forming a part of it, and other current
assets which are essential for the proper maintenance, operation, and
administration of a property. There should be included in a valuation
an amount of working capital sufficiently large, not only to meet the
usual requirements, but to provide for emergencies.

Securities Owned. — Ordinarily, the valuation of property devoted
to public use should not include securities owned, or surplus cash
not forming a part of working capital, except in instances where such
securities and surplus cash are an offset, in whole or in part, for
depreciation deducted from the cost of the property.

Original Cost to Date.

As defined by the Committee, this is the first cost of the identical
property iinits now in use, including overhead charges.

Difficulties. — ^While much of the difficulty of determining original
cost as thus defined in some cases may be removed, especially in
the case of short-lived property, it is not feasible to obtain a depend-
able result where the absence of reliable historic data makes necessary
a resort to estimates, as in the case of old properties consisting mainly
of long-lived items.

Schedule. — Generally, it will be found necessary to prepare a sched-
ule in the same way that one would be made for determining the cost
of reproduction, many adjustments in the records often being required,
even under the most favorable conditions, in order to obtain correct
results.

Costs — Unit Costs. — ^When a schedule is necessary, the correspond-
ing costs or unit costs are essential to the completion of the inventory,
and where these are unobtainable, as is usually true in the case of
property units acquired or created long ago, the ascertainment of the
original cost is impossible.

Overhead Charges. — These are recited at length in the section
relating to cost of reproduction. They are inadequately reflected in the
records, as a rule, and therefore adjustments are required which ai-e
largely matters of opinion and speculation, and which, in couse-



VALUATION OF TUBLIC UTILITIES 1'3'Zl

quenee, make more uncertain the final result thus often destroying its
usefulness.

Development Expense. — The expense, actually incurred in connec-
tion with the tuning up and creation of the business of a property,
should be included as a part of the original cost to date.

Cost of Reproduction.

Theory of Reproduction. — Estimates of the cost of reproduction
should be based on the assumption that the identical property is to be
reproduced, rather than a substitute property; that while apparent
present-day conditions, that would aifect the cost of reproducing the
property, must be considered in any logical estimate, yet history must
also be considered, to determine what is to be reproduced, the condi-
tions under which it is to be reproduced, and how the estimates must
be made; that for all those items concerning which there can be no
doubt the engineer should use the basis plainly applying, and that for
those that are doubtful, or have been questioned, he should present the
effect of the use of the different bases clearly, that the determining
body may have the data for a wise decision; and that normal present
conditions shall determine the prices and methods for doing the work.

Preliminary Worh. — The first step in estimating the reproduction
cost of a property is such a study of the property and its history as
will enable the estimator to make a complete list of all items, lay out
a proper financial and construction programme, and fix proper unit
prices to the several items of the schedule, after which the property
should be divided into groups of items or units which will lend them-
selves to the depreciation study and accounting, preferably following
some well established classification of accounts.

The field schedules and inventories, suitably recorded on appro-
priate forms, should be based not only on full and complete surveys
and inspections of the visible physical property, but they should also
reflect a careful historical search of existing records of original con-
ditions, and other reliable sources of information, bearing on items of
material or work which entered into or were incidental to actual ex-
isting units, special care being exercised to exclude that which is not
capable of definite proof, and to limit the speculative uncertainties as
far as possible.

Unit Prices. — In determining unit prices a rational sequence of
construction should be assumed for the reproduction of a property;
and rational assumptions should be made as to the manner of doing
the different parts of the work, whether by the forces of the company
or by contract. Unit prices based, where possible, on the actual cost
of doing similar work, in a similar manner, under similar circum-
stances, should be determined by persons of experience and sonnd
judgment. They should be based on the normal average cost of work



132,^ VALUATION OF PUBLIC UTILITIES

for a considerable period — say, 5 or 10 years — in order to give sta-
bility to the valuation, so that it may be used for a subsequent term of
years. In the case of items which are steadily increasing or decreasing
in value, the prices adopted should be normal for the time of the valua-
tion. Full consideration should be given to the time allowed for con-
struction, to climatic conditions, and to the effect of any other sig-
nificant conditions or limitations upon the cost of the work.

Ijand Holdings. — Separate parcels of land, such as one or two lots,
or a tract of not unusual size, not connected with other lands of the
utility in a strip or body, and where freedom of choice in selection may
be exercised, should be valued on the same basis as other lands in the
vicinity, used for general purposes.

Where large tracts have been acquired, made up of a niimber of
separate entire parcels, the history of the transaction should be com-
pletely investigated and allowance made in the estimate for costs of
vacation of streets, or acquisition of other rights, incident to the use
of the property as a whole. Such further allowances should be made,
as may seem to be justified by experience, to cover excess costs, over
and beyond the normal market values which existed at the beginning
of the project, and which were due to fluctuations of price or other
causes beyond control. Normal market values of similar and near-by
property, as of the time of appraisal, should be the basis, with such
additions as are warranted by the investigation in each case.

In the consideration of values of lands, for rights of way for a
railroad, an electric railroad, an aqueduct, or other like property, or,
lands for a water-works or an hydro-electric reservoir, where freedom
of choice is restricted and where all the land must be acquired,
radically different methods must prevail.

In the valuation of lands of this class, a clear distinction should be
made between :

(a) Lands where the entire tract or parcel is taken and there is no

element of severance damages;
(6) Lands where only a portion of the tract is taken and where the
element of severance damages is present;

and the extent of lands of both classes should be shown.

Historic conditions, where ascertainable, should be given due
weight in fixing the extent and character of the severance. All ele-
ments of value to the seller, including recognition of all damages to
the portions of his property not taken, which would prevail in the case
of condemnation of the lands under reproduction, should be considered.

A determination of the relation existing between actual recent
acquisition costs and the normal market value of the lands out of which
the strip or parcel was taken at the time of acquisition is undoubtedly
possible in many cases. It would seem that where such relation can



VALUATION OF PUBLIC UTILITIES 1323

be determined, its use in connection with the normal market values of
these or similar lands at the time of appraisal should establish a rea-
sonable cost of reproduction.

The determination of the figure to be used should be based in all
cases on full consideration of the present normal market value of the
area of land acquired and of other recent purchases by the same or
other companies of similar lands in the vicinity or in districts of like
characteristics; the damage to the remaining land, net required, due
to severance and all consequential injuries; the amount and character
of the costs of acquisition and overhead charges; enhanced prices due
to active demand; and any other real items of cost which would be
included in case of purchase. But no allowance should be included
for special values coming after the acquisition of the property on
account of its new use or on account of a greater earning power under
the new use, or for any other hypothetical "value".

Estimates should be based on prices and values as of the time of
appraisal, be they higher or lower than those prevailing at the time
of original acquisition. The thing sought in reproduction is the fair
cost of acquiring the property as of the date of valuation.

The treatment of the valuation of land holdings is not yet
thoroughly crystallized; therefore the valuing engineer will do well
to confer with counsel upon the interpretation of past Court decisions
and the legal principles which are most fairly applicable to the case
under review.

Overhead Charges. — There are certain expenses called overhead
cliarges, inseparable from the construction of any property, which are
a necessary and proper part of its cost, but which are not capable of
physical identification after the completion of construction work.
These expenses cannot be covered in the estimate of "Cost of Eeproduc-
tion" by the application of specific unit prices; from their nature they
attach to the whole or large parts of the property rather than to any
particular units.

Among the expenditures which must be provided for, and classed
as overhead charges are:

(a) Cost of promotion;

(&) Cost of financing and securing the necessary capital with
which to carry out the enterprise;

(c) Cost of organization, including the incorporation and organi-
zation of the company, securing of franchises, and other like
expenditures ;

(d) Engineering, including the making of the preliminary inves-
tigations and plans, plans for the construction of the entire
property, the engineering supervision of all construction and
other work involved in the development of a property, except



132-1 VALUATION OF PUBLIC UTILITIES

such direct supervision as may properly be included in the