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 UNIVERSITY OF CALIFORNIA 
 AT LOS ANGELES
 
 VALUE 
 
 FOR 
 
 RATE-MAKING
 
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 VALUE 
 
 FOR 
 
 RATE-MAKING 
 
 BY 
 HENRY FLOY, A. B., M. A., M. E. 
 
 CONSULTING ENGINEER, FELLOW AMERICAN INSTITUTE OF ELECTRICAL ENGINEERS, 
 MEMBER AMERICAN INSTITUTE OF CONSULTING ENGINEERS, AMERICAN SOCIETY 
 OF CIVIL ENGINEERS, AMERICAN GAS INSTITUTE, ILLUMINATING ENGI- 
 NEERING SOCIETY, AMERICAN WATER WORKS ASSOCIATION, NEW 
 YORK ELECTRICAL SOCIETY, AUTHOR OF "VALUATION 
 OF PUBLIC UTILITY PROPERTIES," "THE 
 COLORADO SPRINGS LIGHTING CON- 
 TROVERSY," "high tension, 
 UNDERGROUND ELEC- 
 TRIC CABLES," ETC. 
 
 First Edition 
 Second Impression 
 
 McGRAW-HILL BOOK COMPANY, Inc. 
 NEW YORK: 370 SEVENTH AVENUE 
 
 LONDON: 6 & 8 BOUVERIE ST., E. C. 4 
 191 G
 
 Copyright. 1916, hy the 
 McGraw-Hill Book Company, Inc. 
 
 PRINTED IN THE UNITED STATES OF AMERICA 
 
 THt MAPLE PRESS - YORK PA
 
 T- 6 6 v^ 
 
 PREFACE 
 
 At the present time, probably the majority of vahiations of 
 pubhc utiHty property are being made in connection with a con- 
 sideration of rates. But different authorities still hold various 
 and conflicting views as to the principles involved in determining 
 
 X the basis of value for rate-making. 
 
 i With the hope of helping define methods used and standard- 
 
 izing practice in valuation procedure, the author ])rought out, four 
 
 ^ years ago, the first book that had appeared relating to the general 
 
 subject, "The Valuation of Public Utility Properties." Since 
 
 that time, several other books have been published, many papers 
 
 written and much discussion elicited, due to the development of 
 
 . . a rapidly increasing general interest in the subject of valuation 
 of utility properties, for the purposes of purchase or sale, rate- 
 making, taxation or capitalization. Despite this activity, it is a 
 disappointment to observe that terms are still used inexactly 
 and opinions are almost as diverse and numerous as there are 
 writers. 
 
 The purpose of this book is an attempt to further emphasize 
 at least three principles that seem to the author to be essential 
 in determining the fair value for use in fixing rates. 
 
 First. — To conform to the rulings of the courts the basis for 
 
 ; rate-making should be the fair present value of the property 
 used, regardless of the amount of the original investment in utili- 
 ties established previous to the present public regulation regime. 
 Second. — Present value for rate-making is obtained by making 
 deduction for absolute depreciation only; ignoring theoretical 
 depreciation. Absolute depreciation being that deterioration 
 which is in evidence, existing and determined by inspection. 
 Theoretical depreciation being estimates only, based on assump- 
 tions and computations. 
 
 Third. — Practically every utility property includes certain in- 
 tangible non-physical elements, which should be evaluated and 
 allowed in addition to the material, sensil)le elements. The 
 value of the non-physical parts may vary from a few per cent. 
 
 rr^*v 
 
 19805^
 
 vi PREFACE 
 
 to a huiulrod pvv cent, or more of the value of the physical parts 
 of a property. 
 
 The author has certain definite views as to the principles to 
 Ix* adopted and the lines to be followed in determining values to 
 \)e used as the basis of rate-making. Therefore, believing that 
 these views will ultimately prevail in the decisions of public 
 authorities, those which seem wrong in principle and likely to be 
 later over-ruled by the decision of final courts, have not neces- 
 sarily been referred to or included in the following pages. 
 
 It maj^ seem presumptious on the part of any one but an 
 attornej'' to criticize, or even interpret, decisions rendered by 
 courts or commissions, but in these matters an engineer who has 
 Ix^en engaged for some years in making valuations, giving testi- 
 mony thereon before courts and commissions, associating with 
 attorneys in preparing cases, and assisting in writing briefs, neces- 
 sarily al)sorbs some legal knowledge and has, perhaps, a better 
 understanding of what is practicable in the construction and 
 operation of utility property than a mere theorist. Finally, a 
 knowledge of legal decisions and procedure must be fitted to 
 facts and figures in order to prepare the proper basis upon which 
 to fix rates. 
 
 Herein will be found much matter that was originally prepared 
 by the author in discussing papers presented before engineering 
 societies, in assisting the writing of legal briefs, or publication 
 in other form, l)ut it is hoped that as here presented, it will tend 
 to make an orderly, logical argument for the principles involved. 
 
 Henry Floy. 
 
 Nkw York City, 
 March 1, 19 IG.
 
 CONTENTS 
 
 Page 
 
 Preface v 
 
 CHAPTER I 
 
 Introduction 1 
 
 Basis for Rates — Right of Regulation. — Development of Law — 
 Federal Valuation. 
 
 CHAPTER 11 
 
 Definitions 21 
 
 Explanatory — Value — Physical or Structural Value — Scrap or 
 Salvage Value — Wearing Value — Service Value — Present Value — 
 Original Cost — Cost to Reproduce New — Development Expenses 
 or Overhead Charges — Good-will — Going Value — Depreciation — 
 Classes of Depreciation — -Obsolescence. 
 
 CHAPTER III 
 
 Fundamentals in Valuation 27 
 
 Before and After Regulation Begins — Competition — Purpose 
 Affects Valuation — Gifts and Donations — Free Service — Agency 
 Theory. 
 
 CHAPTER IV 
 
 Fair Value for Rate-making 54 
 
 Principles Involved — Law and Method — Investment not Value — 
 Basis of Value — Present Value — Court Decisions — Consolidated 
 Gas Case — Fair Rate — Efficiency in Operation and Utilization — 
 Value of Service. 
 
 CHAPTER V 
 
 Cost of Reproduction 100 
 
 Development of Theory — Reproduction New — Construction 
 Schedule — Inventory — Unit Prices — Fluctuating Prices— Contract- 
 or's Profit — Engineering, Architects' Fees, etc.^ — Omissions, Inci- 
 dentals and Contingencies — Insurance — Development Costs — 
 Taxes — Preliminary Expenses — Promotion — Financial Costs — 
 Overhead Charges — Superseded Plant.
 
 viii . COXTEXTS 
 
 CHAl'TllR VI 
 
 Page 
 
 Land, Pavi.nm; and Watku Rights 132 
 
 Land Values — Paving — Water Rights. 
 
 CHAPTER VII 
 
 Fhamhisks. WoKKiNt; Capital and Bond Discounts 157 
 
 Francliises — Working Cajjital — Bond Discount. 
 
 CHAPTEH Vlll 
 
 GoiN<i Value 177 
 
 Cioing Value Must be Allowed — Going Value in Rate Cases — 
 (ioing Value, Four Meanings — Going Value, not Plant Operation 
 — Going \'alue not Rate of Return. 
 
 CHAPTER IX 
 
 Dki'ueciatiun 235 
 
 General Di.scussion — "Absolute" and "Theoretical" Deprecia- 
 tion — Accruing Depreciation not Allowed/ — Depreciation Estimates 
 Inaccurate — Minnesota Rate Cases — Public Utility Decisions — 
 Individual Opinion — Illustrations — Reserve Funds — Depreciation 
 Funds — Value not Fixed by Depreciation Fund. 
 
 Inukx 311
 
 VALUE FOR RATE-MAKING 
 
 CHAPTER I 
 INTRODUCTION 
 
 Basis for Rates. — The determination of the value of property 
 used in serving the pubKc has become a very general requirement. 
 The purpose of such determination is usually to permit the control 
 of public utility properties through municipal, state or national 
 regulatory bodies. Although this present commission form of 
 regulation is a comparatively recent development, it is predicated 
 upon the principle that private ownership may be compelled to 
 provide adequate service at the lowest rates that will furnish a 
 fair return upon the fair value of the property devoted to public 
 service. It will, therefore, be recognized that the determination 
 of property values, in connection with rate-making, is made 
 primarily for the purpose of determining the amount of return 
 to be allowed. 
 
 While the fixing of a fair and reasonable return may seem a 
 complex and difficult question, nevertheless, the determination 
 of the fair value of property is still more complicated. In this 
 connection even so apparently a simple and elementary matter, 
 as the making of an inventory of the physical property of a utility, 
 requires great care, experience and expense. The work must be 
 done in a painstaking manner, involving tedious and almost 
 endless detail, costing relatively large amounts of money, if the 
 results are to be free from error, and capable of substantiation in 
 court. The opportunities for errors in making an inventory are 
 numberless, due not alone to the grade and experience of help 
 that must be employed, in order to keep the cost within boimds, 
 but also to the human element which seldom attains absolute 
 accuracy. Moreover, in many instances, lack of opportunity 
 for close inspection, impossibility of examining unexposed prop- 
 erty, limitations as to the time in which the work must be 
 completed, multiplicity of items and opportunities for misunder- 
 standing, increase the difficulties. 
 
 1
 
 2 VALUE FOR RATE-MAKING 
 
 In order to fix values, even though the inventory is complete, 
 there still remain questions involved in its proper pricing. Some 
 of the difficulties of fixing upon fair and proper costs are due to 
 differences in costs of the same item at different times in different 
 localities, or under different conditions of installation; also as to 
 whether the original cost, to-day's quoted prices, or prices based 
 on the average over a number of years, or the present trend, 
 shall be used; also to the fact that differences in price are made to 
 different parties for the same item, delivered at the same place, 
 at the same time. In addition to these difficulties, percentages 
 must be adopted to cover some allowances that have to be made 
 for items too small to list in the inventory, for contingencies, 
 omissions, engineering, interest and taxes during construction, 
 and other like items. Furthermore, the complicated cost of 
 developing the business, which is generallj^ recognized as proper 
 to include as a part of the value of a going utility, must be com- 
 puted or otherwise arrived at, and finally questions as to the 
 amount to be deducted for depreciation, about which the widest 
 differences of opinion prevail, must be estimated. In order to 
 comply with the rulings of the court, consideration must be 
 given original investment, the amount of outstanding stock, bonds 
 or other securities, as well as the revenue and operating expenses, 
 before fair value can eventually ])e legally determined. 
 
 The primary cause of the existing, widespread agitation, which 
 may almost be called a mania, for the valuation of public utility 
 property arises from a determination to secure a readjustment of 
 charges for or quality in the service, being rendered. This de- 
 termination, while frequently the expression of a proper and 
 reasonable demand on the part of the public, is in too many 
 instances merely the agitation of political office seekers or misin- 
 formed philanthropists aroused by unintentional errors or 
 deliberate wrongdoing of utility managements. Frequently, 
 changes are demanded through ignorance of what may be fairly 
 and practically required of utility corporations. A greater readi- 
 ness on the part of utility managements to impart information 
 as to their business and a greater willingness on the part of the 
 public to study conditions and learn facts and possibilities, would 
 result in the avoidance of many bitter controversies between the 
 public and the utilities. Unnecessarily large expenditures of 
 effort and money are made by public authorities and required of 
 corporations in valuations made necessary by rate controversies
 
 INTRODUCTION 3 
 
 originated by individuals, posing as protectors of the general 
 public, olthough the latter maj'' be well satisfied with existing 
 conditions.^ There can be no question but that many valuations 
 of phj'sical property are to-day being made which cannot be of 
 much practical use, because not made at the time rates are to be 
 determined, or a sale effected. Moreover, in some cases, where 
 fair valuations of utilities could properly be used for adjusting 
 rates or fixing values for sale, improper valuations are being 
 unfairly and illegitimately used. This is brought about by 
 the financial inability or fear of a greater evil than too low a 
 valuation, on the part of the corporations. They, therefore, 
 refrain from attacking such improper valuations, which, being 
 allowed to stand, thereby become legalized through commission 
 or even court decisions, A frequent instance of the error to be 
 found in the rulings of public authorities results from their 
 failure to add to the physical values the other and equally im- 
 portant non-physical values, the sum of which two elements 
 makes up the total value of an operating utility. 
 
 An excellent statement of the basis of value for rate-making 
 was made by President Wilson when he ran for Governor of New 
 Jersey in 1911. A voter of the State propounded this question 
 to him in an open letter: 
 
 "Do you believe that all the public utilities of New Jersey ought to 
 be valued with regard to their physical property alone, and on the value 
 thus found rates should be fixed, which should allow them 6 per cent, 
 on that value?" 
 
 President Wilson's reply was: 
 
 "No, I believe the physical value has an important bearing upon the 
 question, but I also think that all the physical, financial and economic 
 circumstances should be considered in connection therewith."- 
 
 In fixing rates, valuation of the property is by no means the 
 only requirement. The determination of a fair and reasonable 
 rate necessitates, in addition to the valuation of the property, 
 
 1 The single complaint of Mayor Fuhrman of Buffalo as to the service and rates of the 
 Cataract Power & Conduit Company of Buffalo compelled the corporation to spend thousands 
 of dollars in presenting its case before the Public Service Commission, with the resulting 
 illegal decision reducing rates 28 per cent., although the evidence showed that not a single 
 customer of the corporation complained of the excellent service or of the extraordinarily 
 low tariffs (the average price received per kw.-hr. sold was $0.00711) but on the contrary, 
 unanimously commended the corporation. 
 
 ^ Mr. T. N. McCarter in an address before the West Side Y. M. C. A. of New York City, 
 Apr. 13, 1914.
 
 4 VALUE FOR RATE-MAKING 
 
 the passing of judgment upon all kinds of operating conditions, 
 the auditing of accounts and records, which presupposes proper 
 accounting systems, the collection and analysis from various 
 independent sources, of data relating to financial and operating 
 factors of similar properties, and then the formation of a judg- 
 ment by the just and wise weighing and proportioning of the 
 various elements proper in fixing the rate from a consideration 
 of the particular industrial, operating and financial local con- 
 ditions. The principles to be used in ascertaining value for 
 rate-making and their application are important not only to 
 the utilities but also to the customers served. 
 
 Right of Regulation. — The theory of State or Federal control 
 and regulation of corporations is not new, although the principle 
 has recently been greatly broadened. Despite the feeling that a 
 corporation or a monopoly, like an individual, may charge ''what 
 the traffic will bear," it is generally recognized and now univer- 
 sally held by the courts, that with reference to those things that 
 have come to be considered more or less as "necessities of life," 
 the public has the right to demand the service at such price as 
 will insure to the owner under all considerations of the case, 
 merely a fair return upon the value of his property. 
 
 The authority and power to regulate public utilities lies in the 
 Legislature. Consequently, the Legislature may deputize its 
 powers to a commission, or other delegated authority, but it is, 
 of course, axiomatic that the Legislature cannot delegate powers 
 which it does not possess. Moreover, any State Legislature is 
 restricted in its power by the State or Federal Constitutions. 
 Therefore, a commission attempting to evaluate public utility 
 property and determine rates to be charged for service rendered 
 thereby, is limited and controlled in its action by the authority 
 delegated to it by the Legislative body. State or Federal, ap- 
 pointing it, and it has only those powers which are not contrary 
 to the constitutional provisions of the State or Federal Govern- 
 ment. The United States Supreme Court has clearly recog- 
 nized these relations and determined this principle in City of 
 Worcester vs. Worcester Consolidated Street Railway Companj'', 
 196 U. S., 548. 
 
 "The (luostion thon arising is, whether the legislature, in the exercise 
 of its general legislative power, could abrogate the provisions of the 
 contract between the city and railroad company with the assent of 
 the latter, and provide another and a different method for the paving
 
 INTRODUCTION 5 
 
 and repairing of the streets through which the tracks of the railroad 
 company were laid under the permit of their extended location. We 
 have no doubt that the legislature of the Commonwealth has that power. 
 A municipal corporation is simply a political subdivision of the State, 
 and exists by virtue of the exercise of the power of the State through 
 its legislative department. The legislature could at any time terminate 
 the existence of the corporation (the city) itself, and provide other and 
 different means for the government of the district comprised within 
 the limits of the former city." 
 
 The Legislature, not having divested itself, but simply delegat- 
 ing its authority to specified agents, such agents or commission 
 are clothed with the power possessed by the authorizing body for 
 the purpose of protecting the public against unjust practices 
 and methods in connection with the furnishing of service by 
 utilities as well as protecting the utilities against unreasonable 
 demands and unduly low rates sought by the public. In general, 
 the people are entitled in law and equity to adequate service at 
 fair rates, in consideration of which the utility is entitled not only 
 to the protection of its property, but also for the use thereof, to 
 an equitable rate of interest plus a reward, which together make 
 up the fair rate of return. 
 
 Although the public's right to regulate public service corpora- 
 tions is no longer questioned and the establishment of correct 
 principles for determining the value of the property used is most 
 important, the allowance of a fair and proper rate of return is 
 most essential in assuring efficiency and high quality of service. ^ 
 Sacrificing high-class service for a somewhat lower rate results 
 ultimately in dissatisfaction to the public as well as the utilities. 
 
 The right of the public to regulate any corporation depends 
 only upon the character of its business and to what extent it 
 effects the public interest. The recent decision of the Supreme 
 Court upholding, because of the peculiar and close relation of this 
 business to the public, the right of the State of Kansas to regulate 
 fire insurance rates, indicates the extent to which the principles of 
 public regulation has proceeded. Although the opinion was 
 divided in this case the majority of the judges upheld the right 
 of legislative control to fix insurance contracts, in view of the 
 fact that they are a public necessity and monopolistic in char- 
 acter, under the present system whereby rates and contracts 
 are fixed by the agreement of the underwriters. While it may 
 be questioned that the public should generally fix prices, wages
 
 6 VA L r^E FOR RA TE-MA KING 
 
 and rates, the progressive spirit of the decision makes clear the 
 fact that as conditions change — whatever they may have been — 
 public interest begets the public's power of control. The class 
 of corporations in which the public has a regulating interest is 
 indicated by the following extract from the insurance rate 
 decision above referred to: 
 
 "The list of rate-regulated corporations is not too long to be here 
 given. It includes canals, waterways and booms; bridges and ferries; 
 wharves, docks, elevators and stockyards; telegraph, telephone, elec- 
 tric, gas and oil lines; turnpikes, railroads and the various forms of 
 common carriers, including express and cabs. To these should be 
 added the case of the innkeeper (as to which no American case has been 
 found where the constitutional question as to the right to fix his rate 
 has been considered), the confessedly close case of the irrigation ditches 
 for distributing water (193 U. S. 379), and the toll mills acts. This, 
 of course, does not include the case of condemnation for governmental 
 purposes or for roads and waj's where no ciuestion of rates is involved. 
 There may be other instances not found, but it is believed that the fore- 
 going enumeration exhausts the list of what has heretofore been treated 
 as a public business, justifying exercise of the price fixing power against 
 persons or corporations. 
 
 "It is to be noted that in each instance the power to regulate rates is 
 exercised against a business which in every case used tangible property 
 devoted to a public use. Some of them had a monopoly (Spring Water 
 Co. vs. Schlotter, 1 10 U. S. 354). Some of them had franchises. Most 
 of them used public ways or employed property whicli they acquired 
 by virtue of the power of eminent domain. They were therefore : ub- 
 ject to the correlative obligations to have the use, of what had been 
 taken by law, fixed by law. And as further pointing out the character- 
 istics of the public use justifying the fixing of prices, it will be noted that, 
 with the exception of toll mills (which, however, do not emploj' property 
 devoted to a public use), they all have direct relations to the business 
 of the facilities of transportation or distribution — to transportation by 
 carriers of passengers, goods or intelligence by vehicle or wire — to dis- 
 tribution of water, gas or electricity through ditch, pipe or wire; to 
 wharfage, storage, or accommodation of property before the journey be- 
 gins, when it ends, or along the way. 
 
 "Wlicn thus enumerated, they appear to be grouped around the com- 
 mon carrier as the tj'pical business and all cmph)ying in some way 
 property devoted to a public use. 
 
 "It will be seen, too, that the size of the business is unimportant, for 
 the fares of a cabman, employing a broken-down horse and a dilapidated 
 vehicle can be fixed by law as well as the rates of a railroad with niilhons
 
 INTRODUCTION 7 
 
 of capital and tliuusands of cars transporting persons and property 
 across the continent."^ 
 
 The earliest appraisals or valuations of corporation property 
 were made in connection with the purchase and sale of water- 
 works. Later, the excessive profits made or asserted to be made 
 from various utility properties resulted in demands for reduc- 
 tions in the tariffs being charged for the service rendered; conse- 
 quently valuations were required for the purpose of ascertaining 
 whether or not the tariffs charged produced unreasonably large 
 returns upon the values of the respective properties. This 
 right of the public to regulate tariffs was upheld by the courts 
 on the ground that 
 
 "property does become clothed with a public interest when used in a 
 manner to make it of public consequence and effect the community at 
 large. "^ 
 
 Development of Law. — The appraising of corporation property, 
 for the purpose of establishing the fair value of such property, 
 to be used in establishing the just basis of financial transactions 
 between the public and the corporations has been a gradual de- 
 velopment and hence, naturally the more elemental principles 
 were first recognized and established. But even to-day, although 
 the principle of establishing the fair value of corporation property 
 is practically universally recognized and acknowledged as a 
 necessary preliminary step for determining the tariff to be 
 charged for a given service, nevertheless, the basis of such valua- 
 tion and the various elements entering therein are not by any 
 means agreed upon, appreciated or all allowed for in most cases 
 where regulating authorities have been and are establishing values 
 for rate-making. 
 
 The earlier uses of valuations were made in connection with 
 the most simple form of corporation property where the physical 
 property represented all or nearly all of the value of the invest- 
 ment. Under these conditions, the restriction of the meaning 
 of valuation to the value of the physical property was not only 
 natural, but in many cases fair, and yet, even in the earliest 
 decisions of the courts, there was recognized the fact that in addi- 
 tion to the physical property upon which the owners were 
 
 ' German Alliance Insurance Co. vs. Ike Lewis, Superintendent of Insurance, of the 
 State of Kansas. Decided Apr. 20, 1914. 
 "^ Munn vs. Illinois, 94 U. S. 113.
 
 8 VALUE FOR RATE-MAKIXG 
 
 entitled to a return, there might also be included in the tariff a 
 proper charge for the value of the ser%'ice rendered, pro\'ided 
 such charge was reasonable. 
 
 One of the simplest and earUer cases determining the principles 
 of valuation of corporation property for use in ser\'ice to the 
 public that was passed upon by the Supreme Court was in the 
 case of a turnpike road company, which had constructed and was 
 maintaining a turnpike extending from CoWngton to Lexington, 
 Kentucky. After constructing and operating the turnpike for a 
 number of years, the public felt that the charges by the corpora- 
 tion were excessive in view of the increasing traffic, and the Legis- 
 lature passed an Act to compel the corporation to reduce its 
 tariffs. In this case, while the elements of organization were 
 most simple, the annual expenses — primarily those of mainte- 
 nance — and the value of the corporation property were prac- 
 tically all e^^denced by physical property, thus indicating the 
 most elementary- form of value, nevertheless, the Court recog- 
 nized that the value of the service should be considered. 
 
 "So that the right of the public to use the defendant's turnpike upon 
 paj-ment of such tolls as in \new of the nature and value of the ser\-ice 
 rendered by the company are reasonable, is an element in the general 
 inquiry whether the rates established by law are unjust or unreasonable. 
 That inquirj' also involves other considerations, such, for instance, as 
 the reasonable cost of maintaining the road in good condition for public 
 use, and the amount that may have been really and necessarily invested 
 in the enterprise. In short, each case must depend upon its special 
 facts. *****•■! 
 
 Formerly, the courts held that where property was used for the 
 ser%'ice of the public, the regulation of rates to be charged there- 
 for lay entirely in the discretion of the proper legislative body 
 and regulation in these matters was beyond the power of the 
 courts. 
 
 ''It is insisted, however, that the owner of property is entitled to a 
 reasonable comp>ensation for its use, even though it be clothed with a 
 public interest, and that what is reasonable is a judicial and not a legis- 
 lative question. 
 
 As has already been shown, the practice has been otherwise.''^ 
 
 Later, however, the decisions of the courts establishing this 
 principle were re\'ised, because it was recognized that the fixing 
 
 ' Covington 4 Lexington Turnpike Road Company vs. Sanford, 164 U. S. 597. 
 * Munn vs. IllinoU W, L'. S. 133.
 
 ISTRODUCTION 9 
 
 of an unfairly low rate would result in unfairly depreciating the 
 value of the property used in rendering the service, contrary to 
 the Fourteenth Amendment. 
 
 In the case of the Chicago, Milwaukee & St. Paul Railroad 
 Company,^ it was definitely argued that 
 
 "insofar as it (the company) is definitely deprived of the lawful 
 use of its prop)erty. while other pyersons are permitted to receive 
 reasonable profits upon their invested capital, the compan}' is deprived 
 of the equal protection of the laws,' 
 
 that is, if the company was deprived of its right to charge 
 reasonable rates for the use of its property, it was deprived of 
 the lawful use of that property and consequently in substance 
 and effect of the property itself. The Supreme Court, therefore, 
 reversed its pre\'ious decisions contrary- to this contention and in 
 several other and later cases reaffirmed this new position, where 
 it spoke as follows: 
 
 "The^e cases all support the proposition that while it is not the pro- 
 vince of the courts to enter upn^n the merely administrative duty of 
 framing a tariff of rates for carriage, it is within the scope of judicial 
 power and a part of the judicial duty to restrain an}-thing which, in the 
 form of a regulation of rates, operates to deny to the owners of property 
 invested in the business of transportation that equal protection which 
 is the constitutional right of all owners of other property. There is 
 nothing new or strange in this. It has always been a part of the judi- 
 cial function to determine whether the act of one party (whether that 
 party be a single indi^^dual, an organized body, or the public as a 
 whole) operates to divest the other party of any rights of jjerson or 
 property. In everj' constitution is the guarantee against the taking 
 of private prop>erty for public purposes without just comp)ensation. 
 The equal protection of the laws which, by the Fourteenth Amendment, 
 no State can deny to the indi\idual, forbids legislation, in whatever form 
 it maj' be enacted, by which the property of one indi\idual is, without 
 compensation, wrested from him for the benefit of another, or of the 
 pubhc. ■= 
 
 "That there is a remedy in the courts for rehef against legislation 
 establishing a tariff of rates which is so unreasonable as to practically 
 destroy the value of property of companies engaged in the carrj-ing 
 business, and that esp>ecially may the courts of the United States treat 
 such a question as a judicial one, and hold such acts of legislation to be 
 in conflict with the Constitution of the United States, as depriving the 
 
 > Chicago. Milwaukee & St. Paul R. R. Co.. \-s. Minnesota. 134 L". S 418. 
 * Reagan %'s. Farmers" Loan & Trust Co.. 154 U. S. 399.
 
 10 VALUE FOR RATE-MAKING 
 
 companies of their property without due process of law, and as depriving 
 them of the equal protection of the laws."^ 
 
 The Federal and Circuit Courts, following the Supreme Court's 
 decisions in these matters, have upheld the theory that a rate too 
 low to permit a fair return on the value of the property being 
 used for the service of the public is confiscation of that property. 
 
 "A State enactment, or regulations made under the authority' of a 
 State enactment, establishing rates for the transportation of persons 
 or propert}^ by railroad that will not admit of the carrier earning such 
 compensation as under all the circumstances is just to it and the public, 
 would deprive such carrier of its property without due process of law and 
 deny to it the equal protection of the laws, and would therefore be repug- 
 nant to the Fourteenth Amendment of the Constitution of the United 
 States."2 
 
 "As the right to use property for any lawful purpose to the extent of 
 the realization therefrom of a return or reward, commensurate with the 
 reasonable and just value of such use, is an element of property, property 
 itself pro tanto, since, without the right of such use, it would be wholly 
 or partially valueless according to the extent of the restraint upon its 
 use, deprivation of the use thereof, or denial of the power to each such 
 reasonable and just return or reward, by the use thereof, in whole or in 
 part, without compensation therefor, amounts to such wrongful taking 
 thereof, and, therefore, to confiscation within the meaning of the deci- 
 sions in cases of this kind. To constitute such confiscation, the taking 
 need not extend to the corpus of the property nor total deprivation of 
 reward for the use thereof. If the law renders it impossible to obtain 
 from the use of the property a reasonable and fair return, it is confisca- 
 tory^ in its operation and effect, though vahd on its face. The extent 
 of such deprivation is not the test. Whether a statute is thus confisca- 
 tory does not depend upon the amount it takes, in violation of the Con- 
 stitution or the extent to which it interferes with the right of use of 
 property, guaranteed by the organic law. It is void if it so takes any 
 at all or so interferes to any extent whatever. It is condemned not by 
 the extent of the pecuniary injury wrought, but by its transgression of 
 constitutional limits, its invasion of a constitutional right, as sacred to 
 corporations as to the humblest citizen of the land, and justly so, for 
 the reason, among others, that the property of corporations is in fact 
 the property of citizens, and the laws cannot, and ought not, in its 
 ultimate results, to favor one citizen or class of citizens over another."^ 
 
 "The use and profits of property arc themselves property, and are 
 
 ' St. Louis & San Francisco Railway vs. Gill, 156 U. S. 649. 
 
 ^ Smyth vs. Ames, 169 U. S. 526. 
 
 ' Coal & Coke Ity. Co., vs. Conley, 57 S. E. (W. Va.) 0.39.
 
 INTRODUCTION 11 
 
 alike under the protection of the Federal Constitution The 
 
 value of property is the value of its uses.''^ 
 
 "The value of property and of investment in every form is measured 
 by the value of its use, not by its use divorced from the value thereof. "^ 
 
 "But the value of property results from tlio use to which it is put 
 and varies with the profitableness of that use, present and prospective, 
 actual and anticipated. There is no pecuniary value outside of that 
 which results from such use."' 
 
 The title to ownership of property of a pii})lic utility is as 
 complete as that of any individual for the courts have hekl: 
 
 "The property (of the Gas Company) now under consideration is 
 as much the private property of this complainant as are the belong- 
 ings of any private citizen."^ 
 
 The difference between the rights of an individual and a 
 public utility to use and enjoy their respective properties is 
 that the former is not limited as to the amount of return allowed, 
 because that is not a matter of public interest, but the latter, 
 being a corporation in whose operations the public is interested, 
 therefore may properly be restricted in its earnings to a reason- 
 able return upon the value of the property used in rendering 
 service. 
 
 "It is no longer open to dispute that under the Constitution 'what 
 the company is entitled to demand, in order that it may have just com- 
 pensation, is a fair return upon the reasonable value of the property at 
 the time it is being used for the public' "* 
 
 "What the company is entitled to demand, in order that it may have 
 just compensation, is a fair return upon the reasonable value of the 
 property at the time it is being used for the public."^ 
 
 Federal Valuation. — One of the most important public ques- 
 tions at present is the proper charges for transportation to be 
 made by utility corporations. This subject has rapidly de- 
 veloped during the last few years and reached its culmination in 
 an amendment passed by Congress early in 1913, providing for a 
 valuation by the Federal Government of the several classes of 
 property of all common carriers; namely, steam and electric rail- 
 
 ' Spring Valley Water Works vs. City, etc., of San Francisco, 102 Fed. 144, 158. 
 
 ^Shepard vs. Northern Pacific Ry. Co., 184 Fed. 765, 811. 
 
 ^ Cleveland, Cincinnati, Chicago & St. Louis Ry. Co. vs. Backus, 154 U. S. 439, at p. 445. 
 
 ^ Consolidated Gas Co. vs. New York, 157 Fed. 854. 
 
 ^ San Diego Land & Town Co. vs. Jasper, 189 U. S. 442. 
 
 ^ San Diego Land & Town Co. vs. National City, 174 U. S. 739.
 
 12 VALUE FOR RATE-MAKING 
 
 roads, navigation companies, express companies, telephone com- 
 panies, etc., doing an interstate business. This amendment is so 
 far-reaching and is destined to become so important that it is 
 herewith reproduced at length. 
 
 An Act To amend an Act entitled "An Act to regulate commerce," 
 approved Februiiry fourth, eighteen hundred and eighty-seven, and 
 all Acts amendatory thereof by providing for a valuation of the several 
 classes of property of carriers subject thereto and securing information 
 concerning their stocks, bonds, and other securities. 
 
 Be it enacted by the Senate and House of Representatives of the United 
 iStates of America in Congress assembled, That the Act entitled "An Act 
 to regulate commerce," approved February fourth, eighteen hundred 
 and eighty-seven, as amended, be further amended by adding thereto 
 a new section, to be known as section nineteen a, and to read as follows : 
 
 "Sec. 19a. That the commission shall, as hereinafter provided, 
 investigate, ascertain, and report the value of all the property owned 
 or used by every common carrier subject to the provisions of this Act. 
 To enable the commission to make such investigation and report, it 
 is authorized to employ such experts and other assistants as may be 
 necessary. The commission may appoint examiners who shall have 
 power to administer oaths, examine witnesses, and take testimony. 
 The commission shall make an inventory which shall list the property 
 of every common carrier subject to the provisions of this Act in detail, 
 and show the value thereof as hereinafter provided, and shall classify 
 the physical property, as nearly as practicable, in conformity with the 
 classification of expenditures for road and equipment, as prescribed bj^ 
 the Interstate Commerce Commission. 
 
 "First. In such investigation said commission shall ascertain and 
 report in detail as to each piece of property owned or used by said 
 common carrier for its purposes as a common carrier, the original cost 
 to date, the cost of reproduction new, the cost of reproduction less 
 depreciation, and an analysis of the methods by which these several 
 costs are obtained, and the reason for their differences, if any. The 
 commission shall in like manner ascertain and report separately otlier 
 values, and elements of value, if any, of tlie property of such common 
 carrier, and an anal3\sis of the metliods of valuation emplo,yed, and of 
 the reasons for any differences between any such value, and each of 
 the foregoing cost values. 
 
 "Second. Such investigation and report shall state in detail and 
 separately from improvements the original cost of all lands, rights-of- 
 way, and terminals owned or used for the purposes of a common car- 
 rier, and ascertained as of the time of dedication to public use, and the 
 present value of the same, and separately the original and present cost
 
 INTRODUCTION 13 
 
 of condemnation and damages or of purchase in excess of such orif^iiial 
 cost or present value. 
 
 "Third. Such investigation and report shall show separately the 
 property held for purposes other than those of a common carrier, and 
 the original cost and present value of the same, together with an analysis 
 of the methods of valuation employed. 
 
 "Fourth. In ascertaining the original cost to date of the property 
 of such common carrier the commission, in addition to such other ele- 
 ments as it may deem necessary, shall investigate and report upon the 
 history and organization of the present and of anj' previous corporation 
 operating such property; upon any increases or decreases of stocks, 
 bonds, or other securities, in any reorganization; upon moneys re- 
 ceived by any such corporation by reason of any issues of stocks, 
 bonds, or other securities; upon the syndicating, banking, and other 
 financial arrangements under which such issues were made and the 
 expense thereof; and upon the net and gross earnings of such corpora- 
 tions; and shall also ascertain and report in such details as may be 
 determined by the commission upon the expenditure of all moneys 
 and the purposes for which the same were expended. 
 
 "Fifth. The commission shall ascertain and report the amount and 
 value of any aid, gift, grant of right-of-way, or donation, made to any 
 such common carrier, or to any previous corporation operating such 
 property, by the Government of the United States or by any State, 
 county, or municipal government, or by individuals, associations, or 
 corporations; and it shall also ascertain and report the grants of land 
 to any such common carrier, or any previous corporation operating 
 such property, by the Government of the United States, or by any 
 State, county, or municipal government, and the amount of money 
 derived from the sale of any portion of such grants and the value of 
 the unsold portion thereof at the time acquired and at the present 
 time, also, the amount and value of any concession and allowance 
 made by such common carrier to the Government of the United States, 
 or to any State, county, or municipal government in consideration 
 of such aid, gift, grant, or donation. 
 
 "Except as herein otherwise provided, the commission shall have 
 power to prescribe the method of procedure to be followed in the con- 
 duct of the investigation, the form in which the results of the valuation 
 shall be submitted, and the classification of the elements that consti- 
 tute the ascertained value, and such investigation shall show the value 
 of the property of every common carrier as a whole and separately the 
 value of its property in each of the several States and Territories 
 and the District of Columbia, classified and in detail as herein 
 required. 
 
 "Such investigation shall be commenced within sixty days after 
 the approval of this Act and shall he prosecuted with diligence and
 
 14 VALUE FOR RATE-MAKING 
 
 thoroughness, and the result thereof reported to Congress at the be- 
 ginning of each regular session thereafter until completed. 
 
 "Every common carrier subject to the provisions of this Act shall 
 furnish to the commission or its agents from time to time and as the 
 commission may require maps, profiles, contracts, reports of engineers, 
 and any other documents, records, and papers, or copies of any or 
 all of the same, in aid of such investigation and determination of the 
 value of the property of said common carrier, and shall grant to all 
 agents of the commission free access to its right-of-wa}', its property, 
 and its accounts, records, and memoranda whenever and wherever 
 requested by any such duly authorized agent, and every common 
 carrier is hereby directed and required to cooperate with and aid the 
 commission in the work of the valuation of its property in such further 
 l)articulars and to such extent as the commission may require and direct, 
 and all rules and regulations made bj^ the commission for the purpose 
 of administering the provisions of this section and section twentj' of 
 this Act shall have the full force and effect of law. Unless otherwise 
 ordered by the commission, with the reasons therefor, the records 
 and data of the commission shall be open to the inspection and examina- 
 tion of the public. 
 
 "Upon the completion of the valuation herein provided for the 
 commission shall thereafter in like manner keep itself informed of all 
 extensions and improvements or other changes in the condition and 
 value of the property of all common carriers, and shall ascertain the 
 value thereof, and shall from time to time, revise and correct its valua- 
 tions, showing such revision and correction classified and as a whole 
 and separately in each of the several States and Territories and the 
 Digfrict of Columbia, which valuations, both original and corrected, 
 shall be tentative valuations and shall be reported to Congress at the 
 beginning of each regular session. 
 
 "To enable the commission to make such changes and corrections 
 in its valuations of each class of property, every common carrier sub- 
 ject to the provisions of this Act shall make such reports and furnish 
 such information as the commission may require. 
 
 "Whenever the commission shall have completed the tentative 
 valuation of the property of any common carrier, as herein directed, 
 and before such valuation shall become final, the commission shall 
 give notice by registered letter to the said carrier, the Attorney General 
 of the United States, the governor of any State in which the property 
 so valued is located, and to such additional parties as the commission 
 may prescribe, stating the valuation placed upon the several classes 
 of property of said carrier, and shall allow thirty days in which to file 
 a protest of the same with the commission. If no protest is filed within 
 thirty days, said valuation shall become final as of the date thereof. 
 
 "If notice! of protest is filed the coniiiiission shall fix a time for hear-
 
 INTRODUCTION 15 
 
 ing the same, and .shall proceed as promptly as may he to hear and 
 consider any matter relative and material thereto which may be pre- 
 sented in support of any such protest so filed as aforesaid. If after 
 hearing any protest of such tentative valuation under the provisions 
 of this Act the commission shall be of the opinion that its valuation 
 should not become final, it shall make such changes as may be necessary, 
 and shall issue an order making such corrected tentative valuation 
 final as of the date thereof. All final valuations by the commission 
 and the classification thereof shall be published and shall be prima facie 
 evidence of the value of the property in all proceedings under the Act 
 to regulate commerce as of the date of the fixing thereof, and in all 
 judicial proceedings for the enforcement of the Act approved February 
 fourth, eighteen hundred and eighty-seven, commonly known as 
 "the Act to regulate commerce," and the various Acts amendatory 
 thereof, and in all judicial proceedings brought to enjoin, set aside, 
 annul, or suspend, in whole or in part, any order of the Interstate 
 Commerce Commission. 
 
 "If upon the trial of any action involving a final value fixed by the 
 commission, evidence shall be introduced regarding such value which 
 is found by the court to be different from that offered upon the hear- 
 ing before the commission, or additional thereto and substantially 
 affecting said value, the court, before proceeding to render judgment 
 shall transmit a copy of such evidence to the commission, and shall 
 stay further proceedings in said action for such time as the court 
 shall determine from the date of such transmission. Upon the receipt 
 of such evidence the commission shall consider the same and may 
 fix a final value different from the one fixed in the first instance, and 
 may alter, modify, amend or rescind any order which it has made 
 involving said final value, and shall report its action thereon to said 
 court within the time fixed by the court. If the commission shall 
 alter, modify, or amend its order, such altered, modified, or amended 
 order shall take the place of the original order complained of and 
 judgment shall be rendered thereon as though made by the commis- 
 sion in the first instance. If the original order shall not be rescinded 
 or changed by the commission, judgment shall be rendered upon such 
 original order. 
 
 "The provisions of this section shall apply to receivers of carriers 
 and operating trustees. In case of failure or refusal on the part of 
 any carrier, receiver, or trustee to comply with all the requirements 
 of this section and in the manner prescribed- by the commission such 
 carrier, receiver, or trustee shall forfeit to the United States the sum 
 of five hundred dollars for each such offense and for each and every 
 day of the continuance of such offense, such forfeitures to be recov- 
 erable in the same manner as other forfeitures provided for in section 
 sixteen of the Act to regulate commerce.
 
 16 VALUE FOR RATE-MAKING 
 
 "That the district courts of the United States shall have jurisdic- 
 tion, upon the application of the Attorney General of the United 
 States at the request of the commission, alleging a failure to comply 
 with or a violation of any of the provisions of this section bj^ any com- 
 mon carrier, to issue a wTit or writs of mandamus commanding such 
 common carrier to comply with the provisions of this section." 
 
 "Approved, March 1, 1913." 
 
 The first work of appraisal being undertaken by the Inter- 
 state Commerce Commission is that of all of the steam rail- 
 roads of the United States. The importance of this appraisal 
 may be judged from the fact that it is estimated the cost to the 
 Government will be over S20, 000,000 and to the railroads 
 $40,000,000 or $50,000,000 additional. The mileage of the 
 railroads involved, in accordance with the Interstate Com- 
 merce Commission's report for the year ending June 30, 1914, 
 is 377,102 miles of track. There are 1,695,000 emploj'ees, whose 
 wages and salaries for the year mentioned aggregated $1,373,- 
 422,000, as well as innumerable bond and stockholders owning 
 $8,680,000,000 in stock, and $11,567,000,000 of bonds or other 
 funded debt, who will be more or less directly affected by the 
 results of this appraisal. 
 
 The valuation of the property of interstate carriers being under- 
 taken by the Interstate Commerce Commission calls for the 
 ascertaining of the cost of reproducing new the property, the cost 
 of reproduction less depreciation, the actual original cost of con- 
 struction, the amount of stock and bonds outstanding, and the 
 amount of money invested in the property with the source 
 thereof. 
 
 The valuation work of the Interstate Commerce Commission 
 is often referred to as a "physical valuation" and it is assumed 
 that the cost of reproduction of the physical property, with or 
 without depreciation, will be taken as fixing the value of the 
 property of the common carriers, but this is by no means the fact. 
 The United States Supreme Court has repeatedly held that the 
 cost of reproduction new less depreciation, if such exists, while 
 a very important element, is only one factor entering into the 
 final question of value. 
 
 Relatively, it is not a difficult thing to determine the rate of 
 return, but it is a much more complicated and intricate matter 
 to arrive at the value upon which that rate is to be computed. 
 Until the valuation is known, it is impossible to determine what
 
 INTRODUCTION 17 
 
 income the propertj' is entitled to earn, or to fix the just tariffs 
 to be paid by the public. It is a much more difficult problem to 
 establish the rates of return for utilities that compete with one 
 another, as for example the steam railroads, than for other kinds 
 of public utilities that are monopolies, such as water-works or 
 electric light properties. Competitive conditions due to two or 
 more railroads, or between railroads and water transportation 
 operating between the same points, must largely control the rates 
 that niaj^ be charged by the railroads. The rates of one railroad 
 are of necessity bound up with and interdependent upon those of 
 its competitor. The attempt to fix rates for one railroad upon 
 the basis of a fair return upon its fair value, as might be done in 
 the case of a water-works or gas plant, might result in the same 
 rates being most advantageous or detrimental to the competing 
 railroad, depending upon whether the investment made in the 
 latter was larger or less than that of the road whose property 
 had been used in fixing rates. Thus, it will be seen that the 
 problem of establishing individual railway rates or tariffs for 
 particular classes of merchandise transported will not be solved 
 by "physical valuation" or probably not alone by any valuation 
 whatever, but the problems will be enormously simplified, and 
 the knowledge from a reliable source as to the value of the 
 various railroad properties, the character of the investments, 
 the state of efficiency, etc., will confer a great benefit upon the 
 investing public. 
 
 The Valuation Act has been criticised as undertaking more than 
 can be humanly accomplished sufficiently promptly to make the 
 results practically useful. While there may be some justification 
 for such criticism, nevertheless, great and undoubted value will 
 attach to the work already started by the Interstate Commerce 
 Commission, and now well under way, in that the work will give 
 some accurate data on the question as to whether the individual 
 railroads, as well as railroads generally, are enormously over- 
 capitalized as claimed by many, or whether — as a class — the 
 railroads may not have improved their property out of earnings, 
 so that their present fair value closely corresponds to or even 
 exceeds their capitalization. It is recognized by the Interstate 
 Commerce Commissioners themselves that all information called 
 for in the Act cannot be obtained ; for example, the actual, original 
 costs of many of the railroads are not now ascertainable for the
 
 18 VALUE FOR RATE-MAKING 
 
 reason that early records are missing and the knowledge as to 
 these original costs nowhere exists. 
 
 "Experience indicates that it will be possible to obtain with reasonable 
 certaintj^ those facts called for with respect to the corporate and financial 
 history of the carrier, but that it will not be possible in all instances 
 to give the original cost 'in detail as to each piece of property' as called 
 for by the act."^ 
 
 Although definite in many particulars, the amendment fails to 
 define many of the terms it uses, such as the "cost of reproduc- 
 tion new," ''depreciation" and "present value," apparently 
 leaving it to the Interstate Commerce Commission to make its 
 own interpretation of these matters, which will result in values 
 that may be very much higher, or very much lower, than would 
 result if the interpretation of these same terms were made, 
 respectively, by the utility owners on the one hand or the 
 socialists on the other hand. From the statement that the final 
 valuations as found by the Commission shall be "prima facie evi- 
 dence of the value of the property in all proceedings under the 
 Act to regulate commerce," the primary purpose of the legislative 
 amendment is quite commonly believed to be the finding of a 
 basis upon which rates may be determined, but such is not stated 
 to be the only purpose of the valuation. 
 
 Other Bases. — Although appraisals of property are more and 
 more being held as a necessary fact to be considered in arriving 
 at the fair value on which to base rates, many decisions are being 
 made without such facts being available. A recent decision of 
 the Public Service Commission of New York, First District, 
 says: 
 
 "But as a matter of fact, hundreds of rate cases have been disposed 
 of without appraisals. In some instances rates have been lowered, 
 and in others the companies have been allowed to raise rates. While 
 an inventory and appraisal may be of assistance in determining with 
 great precision the exact rate for each class of consumers, they are not 
 absolutely necessary. 
 
 The practice of the Interstate Commerce Commission, throughout 
 its entire history, has been to reduce rates, allow increases or dismiss 
 complaints without resorting to appraisals. In the very important 
 Eastern and Western Rate Advance cases, in the recent proceedings be- 
 fore the Commission, and in the application for advances now pending, 
 
 ' Twpiity-ninth Animal Report of tlic Interstate Commerce Commission, Dec. 1, 1915, 
 I'art I, page 65.
 
 INTRODUCTION 19 
 
 no appraisals have been made, and the raih-oads have not contended 
 that action should be deferred until the physical valuation of their 
 properties has been completed." 
 
 "Whether the record in this case is sufficient to warrant a reduction 
 in rates can only be determined by an examination of the evidence, 
 but there is nothing in the law or in equity that would justifj^ this 
 Commission in taking the stand that it will not alter a single rate of the 
 New York Edison Company until an appraisal has been made." 
 
 The Public Service Commission in Massachusetts has fairly 
 constantly fixed rates without having before it appraisals of the 
 properties considered. It rendered a recent decision as to the 
 Middlesex and Boston Railwaj^ Company granting an increase 
 in rates of fare from 5 to 6 cts. The decision of Oct. 28, 1914, says 
 that while the Massachusetts statute requires the Commission to 
 give "due regard among other things to a reasonable return 
 upon the value of carrier's property," the Commission in passing 
 upon the claims of the corporation that "reproduction cost of 
 the property now being used, less depreciation by w^ear and tear 
 and obsoleteness," should be used as the basis of value, stated 
 "this theory is as inexpedient as it is unjust," falling back upon 
 the amount of the investment as the proper basis upon which 
 to fix rates. 
 
 Although the Interstate Commerce Commission may be able 
 to formulate principles and methods properly applicable in de- 
 termining the value of the property of common carriers, it by 
 no means follows, as recognized by Commissioner Prouty, that 
 such values are the only considerations to be used in fixing rates. 
 The determination of proper rates for railway transportation 
 is such an intricate and extensive matter, the principles of which 
 cannot yet be said to be thoroughly established, that it must be 
 generally conceded the value of the property alone cannot be 
 used for rate-making. In determining any rate, not only the 
 value of the plant and the w^orth of the service must be con- 
 sidered, but also the further fact that the rate must be low 
 enough to secure the business. Furthermore, any rate based 
 on the value of the investment, without consideration of effi- 
 ciency and enterprise, is deficient in recognition of and reward 
 to the element which above all else has made America what it is 
 to-day. 
 
 Moreover, in fixing rates a somewhat more liberal treatment 
 should be accorded rapidly developing pul)lic utilities, such as
 
 20 VALUE FOR RATE-MAKING 
 
 those engaged in rendering electric service, compared with older 
 and more stable utilities, such as water and perhaps gas or 
 seasoned steam railroad systems. As a rule these latter have 
 passed through their formative periods and now present fewer 
 problems, in connection with rate-fixing, than those which by 
 reason of the inability to store their product and because of their 
 recent rapid growth and necessity for frequent discarding of 
 l)lant and apparatus, have created new and less stable economic 
 business problems. 
 
 While existing net earnings cannot be taken as fixing the value 
 of any public utility property, the value of that property will 
 ultimately be determined by the net earnings allowed in any rate 
 case. After the various cost elements are obtained, such as the 
 investment cost, the cost of reproduction, the cost of reproduc- 
 tion less depreciation, and a tentative value found therefrom 
 upon which a tentative rate may be fixed, the real value of the 
 property will result from the actual net earnings. The effect of 
 the net earnings allowed must be considered and their result 
 weighed as a factor in ascertaining the fair value to be allowed. 
 The value to be established is the result of a consideration of the 
 valuation of the property itself and the rate allowed thereon. 
 Th(^ fixing of a value is of itself of no avail unless the return 
 thereon is sufficient to satisfy the requirements of investors in 
 such enterprises and to invite free capital to invest; too low a 
 return will depreciate a value however established. A normal 
 or liberal return will stabilize value and invite investment. It is 
 useless to argue that either cost or investment is market value, as 
 such latter value is only determined by the net earnings actually 
 or prospectively obtained, regardless of what may be determined 
 as the fair value after an appraisal or estimated as profits by 
 a regulating body. Regardless of the methods used in ascertain- 
 ing the so-called value of physical property, with or without 
 its intangil)le values, the ultimate, real value will be determined 
 by the net earnings from the proi)erty and the cost of money in 
 open market.
 
 CHAPTEK II 
 DEFINITIONS 
 
 Explanatory. — Because of the present confused use of words 
 and phrases in connection with rate-making and valuation, some 
 brief definition of the terms used by the author is necessary. 
 
 In too many instances the English language uses the same word 
 for different meanings. In valuation work the call for words 
 to define new meanings, or confused and indefinite ideas as 
 to what is intended, has resulted in the use of the same word to 
 mean different things. 
 
 Value. — Academically the word "value" relates to "barter 
 and exchange." One of the principal causes of demand — there 
 are several — is usefulness or utility; consequently "value" may 
 properly be used to measure utility. In valuation work, as a 
 rule, loss of utility results in loss of value; maximum utility 
 determines maximum value. The ratio of existing to possible 
 utility, measures by the same ratio, when applied to cost as 
 used in its largest sense, the existing value, in dollars, of the 
 commodity or service. If the term related exclusively to barter 
 and sale, only second-hand or scrap values would be considered, 
 which is not the basis on which any appraisal has been or is })eing 
 made for determining fair values of the "used and useful" 
 property belonging to an operating organization. 
 
 Physical or Structural Value. — As the term indicates, physical 
 value relates to material things or substances, the property which 
 can be "seen and felt." It includes, primarily, "those things 
 which are visible and tangible, capable of being inventoried," but 
 secondarily, certain non-physical charges "which are an insepar- 
 able part of the cost of construction but which do not appear in 
 the inventory of the completed property." 
 
 These secondary costs, which are usually included as a part of 
 the physical property, either directly in the unit prices or added 
 afterward in the form of percentages, are expenditures for such 
 items as: 
 
 1. Engineers' and architects' fees, including cost of design and 
 testing all construction and equipment, etc. 
 
 21
 
 22 VALUE FOR RATE-MAKING 
 
 2. Administration expenses chargeable to construction, in- 
 cluding superintendence, inspection, accounting, salaries of 
 officers and clerks, consents of authorities and property owners 
 for temporary work or use, legal expenses, rent, printing, store- 
 room expenses, etc. 
 
 3. Provision for various incidentals and contingencies, incom- 
 plete inventories, unforeseen requirements, etc., which practical 
 experience has shown to be necessary. 
 
 Scrap or Salvage Value. — All physical propertj^ has a certain 
 scrap or junk value, a "barter and sale" minimum basis beyond 
 which there is no depreciation, hence physical property can only 
 deteriorate until it reaches its scrap value. If a property consist- 
 ing of its several elements is usable not as junk but as serviceable 
 property elsewhere, a higher price than scrap value is obtainable, 
 and this worth has been characterized as "salvage value." 
 
 Wearing Value. — If from the cost — taken on whatever basis is 
 determined to be the correct one — there is subtracted "scrap" 
 or "salvage" value of given physical property, the remainder 
 is a value known as "wearing value" (sometimes improperly 
 called service value). 
 
 Service Value. — Physical property, honestly and inteUigently 
 purchased with a view to its suitableness for the service intended, 
 aside from some hidden defect or untoward accident, generally 
 maintains its original utility, and hence its value, for the purpose 
 of use, practically throughout its life, except for such deteriora- 
 tion as results from wear and tear or deferred maintenance. 
 The life of the property may expire normally through age or 
 prematurely through accident, inadequacy or obsolescence, but 
 these latter classes of depreciation develop quickly, so that for 
 the larger part of the time used, the service value of property will 
 approximate the cost. 
 
 Present Value. — The term refers to the fair value of the 
 proeprty at the period being considered. Though not always 
 so, present value usually means the original cost or cost to repro- 
 duce, reduced by the amount of either absolute observed deprecia- 
 tion or theoretical computed depreciation, or sometimes the sum 
 of both of these items. 
 
 Original Cost. — Original cost may be taken to mean the sum of 
 all actual expenditures made to date on a given property — pre- 
 ferably termed investment cost — but more usually it refers to the 
 actual cost of the present existing evidenced items of property.
 
 DEFINITIONS Zi 
 
 Cost to Reproduce New. — Roprodiictioii cost as defiiicHl by 
 the courts refers to an assumed cost, based on the estimated 
 expenditures necessary for reprochicing the property new on the 
 basis of prices current at the time of estimate — prices that 
 fluctuate considerably are averaged for five or more years pre- 
 ceding the date of the appraisal, or adjusted upon some other 
 fair basis — and is made up to include everything that can be 
 inventoried regardless of original cost, age, service value or 
 present condition as affected by depreciation. 
 
 Development Expenses or Overhead Charges. — In connection 
 with the establishment of any utility property, certain expendi- 
 tures are necessary for developing and completing the physical 
 property, aside from the cost of structures. These are in addition 
 to those other expenses of developing the business and producing 
 an income. The former non-physical values may be classed 
 as "Development Expenses" or "Overhead Charges," and the 
 latter as "Going Value," but both items relate to costs — in- 
 tangible because they cannot be seen and handled — and are apart 
 from and in addition to those expenditures relating to the cost 
 of the physical plant. As a class, those expenses incurred in 
 connection with completing the physical property are frequently 
 referred to as "overhead charges," sometimes as "intangible 
 expenses," but as they refer largely to the outlay necessary in 
 getting the physical plant running, the author prefers the quite 
 commonly used term "Development Expenses" which generally 
 cover most or all of the following expenditures: 
 
 1. Legal and other expenses of preliminary promotion, in- 
 corporation and organization, procuring consents of property 
 owners, condemnation proceedings, obtaining franchises, consents 
 and certificates from Public Service Corporations and other 
 public bodies, sometimes title examination and insurance. 
 
 2. Technical expenses in connection with preUminary work, 
 surveys, expert estimates, etc. 
 
 3. Interest on capital and bond issues, wages of superintend- 
 ence and administration not chargeable to construction ordinarily 
 necessary in connection with putting a property in going. order, 
 and also sometimes, although not properly so, the deficiency in 
 operating expenses, taxes and fair return until the property is 
 put on a paying basis. 
 
 4. Taxes of various amounts including corporation tax, 
 mortgage tax, real estate tax, personal property tax, capital
 
 24 VALUE FOR RATE-MAKING 
 
 and State tax, franchise tax, etc., which must be provided and 
 paid before the complete cost of a property is obtained. 
 
 5. Discounts on securities, brokerage or other customary 
 and necessary expenditures in connection with financing a utility 
 and marketing its securities. 
 
 6. Reasonable promotion profit, possibly also some compensa- 
 tion for risk of capital. 
 
 7. Working capital. 
 
 Good-will. — A monopoly, as is generally admitted, has no 
 good- will which can be evaluated, and the courts have sustained 
 this view. Good-will usually results where competition exists, 
 and the tendency of the times is to make no allowance for this 
 element in a public utility valuation, it being considered that 
 good-will belongs rather to industrial enterprises where its value 
 is determined by the profitableness of the business, namely, 
 "capitalizing the net income." 
 
 Going Value. — "Going Value," "Going Concern Value," 
 and "Going Concern" are several terms that have been used to 
 refer to an intangible value beyond that of the physical plant 
 attaching to a live, active -operating and revenue-producing 
 property. The value in question is generally held to relate to, 
 and is evaluated from, a consideration of revenue and earnings. 
 
 Depreciation. — Webster defines "depreciation" as the "act 
 or state of lessening the worth of." The Century Dictionary 
 says it is "a fall in value; reduction of worth." In appraisal 
 work it is used broadly to mean a reduction in utility value 
 expressed as a percentage but more usually in dollars, due to 
 any deterioration in physical plant by reason of: 
 
 (a) Normal wear and tear. 
 
 (6) Age or physical decay. 
 
 (c) Inadequacy. 
 
 (d) Obsolescence. 
 
 (e) Deferred maintenance. 
 
 The term depreciation, always used in connection with a 
 reduction of value, has, however, four distinct and separate 
 shades of meaning, so that the term must be qualified when 
 used in order to distinguish which one of the following meanings 
 is intended: 
 
 First. — The annual amount, expressed as a percentage or in 
 dollars, that should be laid aside to renew or replace the article in 
 question at the timo of its abandonment.
 
 DEFINITIONS 25 
 
 Second. — The annual amount, expressed as a percentage or in 
 dollars, that should be laid aside to renew or replace the article 
 in question at the time of its abandonment, plus the annual 
 expense of maintenance and repair expended in removing such 
 part of depreciation as is practicable and good economy. 
 
 Third. — The total amount — usually that estimated as neces- 
 sary to be expended to put the physical property in perfect operat- 
 ing condition — determined by the inspection and observation of 
 an experienced engineer, expressed in a percentage or in dollars, 
 which must be deducted from the "original cost" or the "cost 
 to reproduce new," in order to determine the absolute, actual, 
 present value. 
 
 Fourth. — The total amount — it may be the sum of several years 
 of depreciation — computed from "expectancy of life" tables, 
 more or less authoritative, expressed in a percentage or in dollars, 
 that must be deducted from the "original cost" or the "cost to 
 reproduce new, " in order to obtain the theoretical, present, de- 
 preciated value. This value may be increased or reduced by the 
 condition of the property, as determined from inspection. 
 
 Classes of Depreciation. — The subject of Depreciation, from 
 an engineering — not an accountant's — standpoint, practically 
 divides itself into several classes, as follows: 
 
 (a) Wear and Tear, or Maintenance. — This includes such de- 
 preciation as may ordinarily be removed or offset by proper ex- 
 penditures at such time as the worn-out parts may be economic- 
 ally replaced. Few parts of physical property in use ever become 
 completely worn out; after a certain amount of wear, a point is 
 reached at which good engineering requires their replacement; 
 they may be still further used, but only at the cost of economy or 
 safety. 
 
 (6) Age, Physical Decay or Decrepitude. — Depreciation of 
 this sort is due to the aging of apparatus that usually has a 
 life extending over a period of years. Property that is short- 
 lived usually passes away through "wear and tear." In many 
 instances, age depreciation will be the same whether the apparatus 
 is used or unused, i.e., a boiler or an insulated wire will deteriorate 
 through the action of the elements practically as rapidly when 
 standing idle as when in continued service. 
 
 (c) Inadequacy or Supersession. — This class of depreciation 
 arises from increased demands of or opportunity for service so as 
 to render the property in use inconvenient or uneconomical for
 
 20 VALUE FOR RATE-MAKING 
 
 continuance of operation, although in every way capable of 
 performing the service for which it was installed. 
 
 (d) Obsolescence. — Obsolescence means the depreciation of prop- 
 erty through the development of something newer and either 
 more economical or more of a fad. Like inadequacy, it may ne- 
 cessitate the abandonment of property long before it is worn out 
 and in many cases, arises largely from demands of the public. 
 
 (e) Deferred Maintenance. — The several classes of depreciation 
 hereinbefore referred to assume that the propert}^ will be kept in 
 good operating condition and efficiency. If the condition of the 
 property is permitted to lapse beyond that of safety or economy 
 in operation there results a condition due to neglect of proper 
 maintenance and regular repairs, a condition known as "Deferred 
 Maintenance."
 
 CHAPTER III 
 FUNDAMENTALS IN VALUATION 
 
 Before and after Regulation Begins. — In questions relating 
 to rate regulation of public utilities, the determination of value 
 is fundamental. Yet it is with regard to the definition of value 
 that the chief controversy and difference of opinion exists. The 
 general principle that public authorities have the inherent 
 right to regulate utilities is now generally accepted. The present 
 rate of return to be allowed upon the value of the property may 
 generally be agreed upon within reasonable limits. The 
 allowance for operating expenses is not usually a subject of con- 
 troversy. The fact that something must be set aside to cover 
 depreciation is generally conceded, and the amount thereof can 
 usually be determined fairly accurately. But the value of the 
 property, the amount of which so largely affects the total revenue 
 to be allowed in rate fixing, will be found to vary widely, depend- 
 ing upon the premises used in arriving at the value. 
 
 Until within the last few years net earnings have been considered 
 a fair and safe basis on which to predicate the value of a given 
 property. Either market value or par value of stocks and bonds 
 outstanding for a given property have, in many instances, been 
 taken as the value of the property itself. Both these bases have 
 been recognized and approved by the lower and higher courts as 
 authoritative evidences which must be considered in fixing the value 
 of any given property, but with the development and progress of 
 the present era of public regulation, less weight and considera- 
 tion have been given to net earnings and capitalization in fixing 
 upon the value of utility property to be used as the fair basis 
 upon which to predicate rates. The reasons for this view 
 are just and fairly conclusive. The present day tendency is to 
 determine value primarily either from the amount of the invest- 
 ment which can be shown to have been fairly, honestly and use- 
 fully made, or from the estimated cost of reproducing the 
 existing property, either with or without deducting depreciation. 
 Although each of these two methods of determining value has 
 many supporters and adherents, too often the controlling in- 
 
 27
 
 28 VALUE FOR RATE-MAKING 
 
 fluence in the adherence to either principle is some element of 
 self-interest. As a matter of fact, both methods of arriving at 
 value, so apparently diverse, are being used, and if properly- 
 applied and with a view to doing justice in the premises, both 
 may be approved. The principal differences of opinion that exist, 
 then, between the various authorities attempting to establish 
 proper methods of valuation and rate-making, relate to proper 
 interpretation of the meaning and application of value new, and 
 the proper use of estimates of depreciation. The reason for 
 these differences of opinion are due primarily to the failure to 
 distinguish between : 
 
 (a) Principles that should be applied in reference to long- 
 established and existing utilities. 
 
 (6) Principles that should be applied with reference to utilities 
 newly created under commission regulation, or that may be created 
 in the future. 
 
 The serious question at present is, not what possible theories 
 and methods may be developed for ascertaining the value and 
 determining the depreciation of utilities yet to be created, but 
 rather what methods of valuation shall be followed in appraising 
 the many existing and long-established utilities. 
 
 Probably everyone would agree that any specific rulings may 
 be correct, provided they are applied only to newly created 
 corporations in which investors placed their money after due 
 notice as to the methods that would be applied and the returns 
 which would be securable therefrom, but it is absolutely unfair, 
 and probably illegal, to attempt to saddle untried, theoretical 
 methods upon innocent owners who invested their money under 
 conditions and upon assumptions entirely different from those 
 now proposed. 
 
 The fact that new and unaccepted conditions cannot after- 
 ward be imposed upon a utility which has made an investment 
 upon definite premises, is not only in line with court rulings but 
 even past misdecnls have been excluded from considcsration in 
 fixing flic l)asis of present valuation. 
 
 "But in this process of condemnation of property, the owner is not 
 to be punished for past misuse of it."^ 
 
 Ttie unfairness and illegality of attempting to apply ex post 
 facto rulings to utility regulation is ably stated by Commissioner 
 
 ' Kennebec Water District vs. City of Waterville Et al., 97 Me., 18o.
 
 FUNDAMENTALS IN VALUATION 2<) 
 
 Eshleman, Ex-President of the Railroad Commission of California, 
 in dissenting from an opinion written by his fellow Commissioner, 
 Mr. Thelen, in the following language: 
 
 "While I do not for a moment question the power of any govern- 
 mental agency to impose conditions in advance on any business requir- 
 ing governmental sanction to be carried on, on the acceptance of which 
 conditions may depend the right of any person or corporation to conduct 
 such business, yet I do not conclude that this power to impose condi- 
 tions in advance necessarily implies the power to impose added condi- 
 tions on a business already operating under governmental sanction 
 after such business has assumed all the obligations required by law 
 to be assumed at the time of the initiation of its enterprise. For 
 example, I am very sure that a condition in a franchise to the effect 
 that never shall the agency accepting such franchise capitalize it or 
 claim value for it at more than its cost, or any value at all for that 
 matter, would be good and enforceable against the agency accepting 
 such franchise. Likewise do I believe that a condition in a franchise 
 requiring the one accepting the same to account as agent to the authority 
 granting such franchise would be equally valid. It would have sim- 
 pUfied matters immeasurably, both for pubUc utihties and public 
 authority had such public authority been far seeing enough to have 
 attached conditions to all gifts, such as I here suggest, but failing to 
 do so in advance, I very much doubt the power of the State to impose 
 them now. I, of course, should not be understood here as urging that 
 the State lacks all power to impose conditions on corporations or 
 persons engaged in any kind of business at a subsequent stage of the 
 existence of such business, which it did not impose at the initial period. 
 All agencies, of whatsoever character, embark on their enterprises in 
 full legal contemplation of the power of the State, should the need 
 arise, to exercise every governmental function which the State may at 
 any time exercise and the subsequent necessity for the government 
 to act in any particular way it may be called upon under its power 
 to act, is as a condition subsequent accepted by all who live under 
 government. The general authority of a State of this Union, under its 
 police power, or the Federal Government under any of its delegated 
 powers to impose conditions upon a busness at any stage of its existence, 
 is not that to which I here refer. All readily agree that such authority 
 is a general condition imposed at the beginning and always existing. 
 But unless referable to the police or other general power of the State 
 of California, this State has no power to impose conditions on any 
 enterprise which has lawfully acquired its property and initiated its 
 business except as a condition precedent imposed upon such enterprise 
 in the beginning, unless the owners of such enterprise voluntarily 
 accept such condition. In other words, the State has the right to say
 
 30 VALUE FOR RATE-MAKING 
 
 in advance upon what conditions a utility enterprise may initiate and 
 conduct its business and may, as a part of the contract, impose con- 
 ditions on the acceptance of which the agency so accepting becomes 
 bound thereby, but faihng to do so in advance the only conditions that 
 may be imposed thereafter are those conditions authorized and justified 
 by the police power. It is my belief, therefore, that the failure of the 
 State to impose conditions in advance divests it thereafter of the power 
 of imposing such conditions unless the police power authorizes such 
 imposition. 
 
 I feel it best to meet this squarely rather than delude ourselves longer 
 in the belief that we as a people may continue safely to divest ourselves 
 of things of value with no return until all the common store is exhausted, 
 in the belief that our mistaken generosity will be reciprocated by those 
 accepting our gifts. They will not reciprocate, and under the law 
 they may not be forced to give back that which we have so foolishly 
 and bounteously granted."^ 
 
 There is a general tendency to ignore the fact that newly organ- 
 ized utilities, originated under present-day regulation cannot be 
 treated the same as long-established utilities which have been 
 created and operated without much restriction as to their tariffs 
 or rates of return. To undertake to establish an intelligent and 
 fair basis for fixing rates, there must be drawn a sharp line of 
 demarcation between those principles that may be applied to a 
 corporation existing and long-established, or one which may be 
 originated, under newly inaugurated, public-service regulation. 
 This does not assail or refute the principle that in both cases 
 present value is to be determined, but it does recognize the fact 
 that methods of getting at the present value may properly differ. 
 
 Where utility property has been constructed and put into 
 operation before the creation of regulating commissions, the 
 investors, with the consent of municipal, state or federal authori- 
 ties and the sanction of the public at large, were allowed to do 
 certain things which are no longer permitted under utility regula- 
 tion. For example, the utilities have generally been allowed to 
 take as earnings and use, as the property of the owners, all 
 revenue above that required, in the opinion of honest directors, 
 for paying operating expenses, interest and taxes or the accunm- 
 lation of surplus. Since the origin of public regulation, due in 
 some measure to the fact that certain corporations, through 
 their directors, have used poor judgment or violated their 
 
 ' Decision of the Railroad Commission of California, Town of Antiodi vs. Pacific Gas and 
 Electric Compiiny, Cuh<! No. 400; Decision .N'o. 10.")5; July 6, 1914.
 
 FUNDAMENTALS IN VALUATION 31 
 
 fiduciary relations or have rendered abnormally i)o()r scivicc, 
 there has resulted a demand that the corporations not only 
 maintain their properties in first-class operating condition, hut 
 in addition accumulate reserve funds which shall be held in 
 cash, property or its practical equivalent. This innovation 
 and the setting up of new rules by public service commissions 
 or other authorities may not be questioned and is eminently 
 fair as to the application of future revenue, provided the cor- 
 porations are permitted to make earning sufficient to carry out 
 such program, but the attempt to confiscate property by the 
 application of such rules to the past is not fair and cannot be 
 sustained. 
 
 This is by no means claiming that because owners have, in the 
 past, taken all earnings and made no provisions for renewals and 
 replacements, the entire cost of such renewals and replacements 
 must necessarily be paid for by the public in addition to a fair 
 return on the value of the property. If, as is the case with many 
 existing utilities, the earnings in the past have been insufficient 
 to pay more than operating expenses and a fair return on the full 
 value of the property, then the public not heretofore having 
 provided sufficient to cover anticipated depreciation, must have 
 the cost of all future renewals and replacements included in future 
 tariffs. On the other hand, if the public has been paying suffi- 
 cient to provide both fair return and an allowance for depreciation, 
 both of which amounts have been taken by the owner as profits, 
 that portion of the total taken, which is applicable to the 
 depreciation account, must be provided by the owner at the 
 time renewals and replacements are necessary, either by fore- 
 going all or part of his future return or providing cash from out- 
 side sources without increasing the investment or property values 
 upon which rates are fixed. In any number of cases, stock- 
 holders are doing this very thing, viz.: foregoing dividends to 
 provide renewals, and such method of maintaining property 
 in no way controls the basis of rates. Where a corporation is 
 created and the money of the owners is invested, after notice, 
 under conditions prescribed in advance by regulating bodies, 
 there can be no fair or honest objection to the insistence upon 
 accumulation of depreciation funds out of revenue and the use 
 of such funds in any reasonable way, but they cannot necessarily 
 be used as a measure of the present value of the property on 
 which rates are to be fixed.
 
 32 VALUE FOR RATE-MAKING 
 
 With respect to corporations that have been in existence for a 
 considerable period of time without commission regulation, and 
 have been following certain generally accepted principles with 
 the acquiescence more or less definite, of public authorities, it is 
 manifestly unjust to determine value for rate-fixing purposes by 
 deducting from the cost of reproduction new, a computed but not 
 accumulated amount of theoretical depreciation, which it is as- 
 sumed should have been amassed in a so-called reserve fund. 
 Such method after notice by the regulating body, may possibly, 
 under some circumstances, be reasonable when applied to certain 
 newly organized corporations, but they are unfair as applied to 
 most existing corporations. That the same rules may not fairly 
 be applied equally to all utility corporations, thus so differently 
 originated, has been recognized by the Railroad Commission of 
 California. 
 
 "We find a condition brought about by proceedings which took 
 place before the Public Utilities Act went into effect which probably 
 we would not have authorized in their present form. The applicant 
 desires now to go forward from this point and to take other steps which 
 in our opinion, standing alone, considerations of public policy would 
 not prevent." (Page ISS^.) 
 
 "Heretofore, in dealing with its financial affairs, we have imposed 
 certain conditions with a view to the ultimate consummation of the 
 objects for which the company was formed, but have been more lenient 
 in this regard than we would be if the enterprise were one which had its 
 inception after the passage of the Public Utilities Act." (Page 665 ^) 
 
 Public utility properties can be operated satisfactorily to the 
 owners, and can be made to render reasonable and adequate 
 service to the public, under either of the methods of regulation and 
 control referred to, namely: 
 
 (a) An assured return, commensurate with the nature of the 
 guarantee, upon the investment made by the owners. 
 
 (b) A variable return, commensurate with the risks of the 
 business, upon the present fair value of the property used. 
 
 The present trend of public service commission rulings is toward 
 the former, that is, the investment cost; nevertheless, such basis is 
 not sanctioned by the United States courts. The United States 
 Supreme Court, in a long line of decisions, has adhered to present 
 value and not original cost as the proper basis upon which to fix 
 rates. This divergence of view and fundamental difference in the 
 
 ' Ucporta Uuilroad f'oiiiniission of California, Jan. 1, Ittll, to Dfo. .'{1, 1912.
 
 FUNDAMENTALS, IN VALUATION 33 
 
 rulings and decisions of these two classes of authorities must be 
 kept clearly in mind in all valuation work, particularly where the 
 values determined are to be passed on by the courts. 
 
 To arrive at impartial fairness in regulation, it must be rec(jg- 
 nized that the public utility companies are not starting simul- 
 taneously with utility regulating commissions. Regulation 
 enters the field with the utility corporations already in full swing. 
 In well-established, going utilities speculative profits are not 
 necessary for the future but have been in the past. Pul)lic 
 regulation in fixing the allowable value is apt to consider only 
 the present and forget the speculative element. The fact that a 
 different status exists as to corporations ))efore and after public 
 regulation begins is clearly recognized by the Interstate Com- 
 merce Commission. 
 
 " * * * if any government tribunal is to do justice between the railway 
 and the public, if it is to feel any confidence in the correctness of these 
 conclusions, this supervision must be continuous and not spasmodic. 
 There must be some point of departure and from that point knowledge of 
 the government must be accurate and complete. After earnings have 
 been 'capitalized' and benefits have been 'completed,' when the various 
 independent organizations have been perfected, it is impossible either 
 to know or to undo."' 
 
 The point to be made clear is that no ex post facto rulings 
 should be attempted or countenanced by commissions or other 
 authorities simply because, for example, a corporation has no de- 
 preciation reserve fund in hand. Who shall say that, because 
 utilities had not accumulated reserve funds before the present 
 character of public regulation was instituted, therefore, the cor- 
 porations shall now be deprived of a part of the value of their 
 property. In determining rates where the public and corporations 
 have consented to the existence of a certain thing in the past that 
 is not legally or criminally wrong, and about which there still 
 exists honest differences of opinion, it is not fair or right, in mak- 
 ing rulings for the future, to attempt to apply such rulings to the 
 past at the sacrifice of investment or the jeopardy of income. 
 It is on this point — the difference between a corporation already 
 in existence and one originated under new laws — that the mis- 
 takes have been made in the rulings of commissioners, very 
 many of whom, inexperienced in utility corporation affairs, have 
 
 ' Decision of the Interstate Commerce Commission, Spokane vs. Northern Pacific Uwy. 
 Co. 15 I. C. C. R. 416.
 
 34 VALUE FOR RATE-MAKING 
 
 attempted to apply theoretically perfected methods which are 
 largely the result of devolopm(>iit and experience. It is the old 
 truth, that the same medicine will make some men well and others 
 ill. 
 
 Competition. — In attempting to establish principles, it must be 
 recognized that while there are certain general applications that 
 relate to all utilities, there are special considerations which 
 apply to particular classes of utilities and which do not hold for 
 other classes. A utility that is entirely local in its interests, as 
 for example, a municipal water-works system, or a local electric- 
 light or gas company, may properly have its rates fixed without 
 much regard to the rates being charged by similar utilities in other 
 localities where operating expenses may be lower or higher, the 
 quantity and local habits of use of service, or the amount of 
 investment required is entirely dissimilar. In instances where 
 such monopolistic utilities are being considered, the principles 
 to apply are not in all respects the same or comparalile in ascer- 
 taining fair rates, that hold if competition is allowed to prevail. 
 The rates to be charged for local service by a local monopoly is 
 distinct from, and not controlled by, the rates permitted in some 
 other locality; the local rates may primarily be determined 
 from a consideration of the value of the property but such basis 
 alone will not apply where competition exists, as in the case of 
 two or more railroads operating between the same terminals. 
 Under such competitive circumstances, the rates for one road 
 must necessarily be fixed from a consideration of what is chaiged 
 by the other road and perhaps without much relation to the value 
 of the respective railroads. 
 
 For example, between New York City and Buffalo, there are 
 five steam railroads, with entirely different grades; some trav- 
 ersing valleys and being fairly level, while others have heavy 
 grades. One is a four-track road of the best type of construction ; 
 the others have less track capacity, but represent a greater or less 
 investment per unit of length, on accovmt of tunnels, or other 
 local conditions; nevertheless, the rates for freight are identical 
 between the two points named over all of these routes, and except 
 for slight differentials with regard to one road, the passenger 
 rates are the same. A valuation of the properties of these five 
 roads would show greatly varying investments, and yet, in order 
 to maintain their respective amounts of business, the roads nuist 
 continue to make the same charge for the same service, although
 
 FUNDAMENTALS IN VALUATION :ir, 
 
 that charge may in tlic one (;ase earn a haiulsonio roturn (o the 
 investors and, in another case, hardly earn operating and depre- 
 ciation charges. The Interstate Commerce Commissioners have 
 recognized this condition of affairs and stated that rates cannot 
 1)6 based on valuation alone, although that necessarily is one of 
 the elements to be taken into consideration. 
 
 "With the railroad, however, this is entirely different for the reason 
 that it seldom happens that a single railroad can be considered by itself. 
 The greater part of the business of the railways of the United States 
 is subject to competitive conditions of one sort and another which arc 
 largely controlling so that the rates of one are necessarily bound up 
 with those of another. A moment's thought will show the extent to 
 which this is true." 
 
 "It is impossible to shake a single railroad free from every other and 
 fix its charges upon the basis of a fair return upon its fair value as you 
 would in case of a gas or water plant. The rate established for one, of 
 necessity influences and frequently absolutely determines the rate of 
 all, a fact which must never be forgotten in discussing the subject."' 
 
 In attempting to get at the value of utility property certain 
 peculiar or local qualifying conditions may fairly modify the 
 results. 
 
 "The first railroad which the Commission is proceeding to survey 
 in what is known as the Pacific District is the San Pedro, Los Angeles 
 & Salt Lake, extending from San Pedro, California, to Salt Lake City, 
 Utah, some 800 miles. Most of this road has been built in compara- 
 tively recent times, and the circumstances and cost of construction are 
 fairly well known. 
 
 "The course of the road is for the most part through an arid desert. 
 A certain section of it, when built, was located where no man tliouglit 
 it could ever be disturbed by floods, yet shortly after it was opened for 
 operation the floods Came and carried out this portion. It was at ont-c 
 reconstructed upon a new location supposed to be beyond all possible 
 danger from a recurrence of the previous disaster, nevertheless the 
 waters again came and washed away this same section; whereupon 
 it was rebuilt upon a third location, beyond all possible reach of future 
 trouble from this source. 
 
 "Considering the nature of the road and the people who were in- 
 terested in its construction, it seems probable that due caution was 
 exercised in the original location; that is, that a reasonably prudent 
 man building this railroad as those men did, to be operated by them as 
 
 '"The Valuation of Railroads" by Hon. C. A. Prouty, delivered before the Second 
 Annual Meeting of the Chamber of Commerce of the United States, Washington, Feb. 11, 
 12 and 13, 1914.
 
 36 VALUE FOR RATE-MAKING 
 
 a railroad, would have located it as it was located. It is undoubtedly 
 true that the second location was made with great care, and was be- 
 lieved to be beyond possible danger. It has cost a large sum more to 
 rebuild this road than it would have originally cost to construct it 
 where it is to-day. Now in determining the value of this property, 
 what, if any, allowance is to be made for this experimental outlay? 
 If the government itself had constructed this railroad it probably would 
 have had the same experience and would have expended the same 
 amount of money which the owners actually did. 
 
 ''This illustration puts the question in a very striking form, but the 
 same idea enters more or less into the valuation of most of the railroads 
 of this country. There has of necessity been a certain amount of 
 experiment before hitting on the right and proper thing. Does this 
 development expense substitute an element of value which may be 
 recognized to-daj^ or must the owners of these public utilities stand the 
 loss of their mistakes in the same way that the owner of a private 
 enterprise would? Vast sums of money are involved in the answer to 
 that very simple question. 
 
 "Take another illustration of a different character. Some years 
 ago in a case pending before the Commission the Northern Pacific 
 Railway Companj^ had occasion to prove the value of its property, and 
 it did so by showing the cost of reproduction. For this purpose it 
 gave the units which entered into that railroad as it then stood. Among 
 other things it showed the amount of land upon which its right-of-way 
 was located and what it would cost to acquire that land for railroad 
 purposes at that time, claiming that this cost of reproduction was the 
 value of the property. 
 
 "The Northern Pacific runs through the City of Spokane. When 
 the road was built, that city was of small account but it has come to 
 be of much account, and in the process of development it has grown up 
 on both sides of this railroad. The Northern Pacific claimed, and it 
 may very well have been true, that the cost of acquiring its right-of-way 
 through the heart of the city of Spokane at the time of the hearing 
 would be at least $5,000,000. The original cost to the railroad was 
 nothing, the right-of-way having been entirely donated either by 
 the Government or l)y private Ijenefaction. Now to whom belongs this 
 $5,000,000? Has the Northern Pacific the right to tax the public 
 for a return upon that amount? Whether it has is a thing of great 
 consequence, for nearly one-fourth of the entire value of the Northern 
 Pacific Railway, as shown in that proceeding, was the value of its right- 
 of-way, much of which was due, as in the City of Spokane, to increase 
 in value over its original cost. This question of the unearned increment 
 presents in the valuation of our railways a difficult problem. 
 
 "Illustrations like those two might be indefinitely multiplied, but 
 these are sufficient to cxliibit the thought I wish to emphasize, namely,
 
 FUNDAMENTALS IX VALUATION 37 
 
 that this valuation of our railways is not a mere engineering problem, 
 involving the cost of reproduction or the amount of depreciation alone. 
 Indeed, it is not properly an engineering problem at all, but rather a 
 social and economic problem; a legal problem; in its final analysis a 
 political problem. It is for the Commission first of all to ascertain 
 all these facts, and from them to deduce what in its opinion is the fair 
 value of the properties. 
 
 "To marshal every fact obtainable with respect to the present 
 condition and the past history of our railways, and from a just con- 
 sideration of all these facts to determine the fair value of the proi)erties 
 to-day."i 
 
 It will be seen that the rates charged by one road cannot be 
 fixed by it, or even by the Interstate Commerce Commission, 
 without consideration of what other roads will charge for similar 
 traffic between the same points, otherwise such a road would im- 
 mediately begin to attract or drive away business to the detri- 
 ment or advantage of the competing lines. This matter was 
 very clearly demonstrated in the Minnesota rate cases, where the 
 Supreme Court ordered the Great Northern and Northern Pacific 
 Railroads to reduce their rates between certain points, although 
 permitting the St. Louis and Minneapolis Railroad to continue 
 the existing rate. The latter road, unable to continue getting its 
 business at the higher rate, was compelled to meet the reduction 
 made in accordance with the Court's order by its two competitors 
 and therefore, reduced its own rates, although thereby it was 
 unable to earn a fair return upon the value of its property. 
 
 Hence it will be seen that rate-making in connection with 
 purely local monopolies may proceed on one basis that is 
 different from that which can be assumed as applicable to utility 
 properties competing with one another. 
 
 Until comparatively recent years, corporations, like individ- 
 uals, have been permitted to largely regulate their own affairs. 
 With the development of corporations that have gained complete, 
 or practically complete, control of any given fine of comnuMcud 
 activity, there has arisen a popular demand for the restriction, 
 regulation, or disintegration of such monopolies. This recent 
 demand, called socialistic by some, is so contrary to what custom 
 had previously permitted, and even courts had sanctioned, that 
 many still believe the rights of the monopofistic corporations 
 
 1 "The Valuation of Railroads" by Hon. C. A. Prouty, delivered before the Second Annual 
 Meeting of the Chamber of Commerce of the United States, Washington, Feb. 11.1- 
 and 13, 1914. 
 
 1980 

 
 38 VALUE FOR RATE-MAKING 
 
 have been infringed and their property is being confiscated, as the 
 result of governmental regulation or disintegration. Where 
 bona fide competition exists it usually succeeds in forcing satis- 
 factorily low rates in industrial enterprises and it is in the 
 attempt to restore former conditions of free competition that the 
 Sherman Act was passed by the Federal Government. Its 
 enforcement it is still hoped by many, will succeed in restoring 
 free competition, with its accompanying lower prices and the 
 former incentive and stimulus to invention and development in 
 industrials, but competition has been shown to be and is generally 
 accepted to be the wrong method by which to control public 
 utilities. 
 
 While it may be considered doubtful whether the artificial dis- 
 memberment of monopolies can result in restoring bona fide 
 competition, there is no question but that in many instances 
 monopolies are desirable. They avoid duplication of investment, 
 usually reduce charges per unit manufactured, proportionately 
 reduce overhead, non-productive expenses of a corporation, and 
 eliminate the losses frequently involved in real competition, 
 which losses the public, or the investor, must ultimately bear. 
 Whatever may be accomplished in the way of maintaining 
 competitive conditions between individuals or corporations 
 engaged in the same lines of business, monopolies must of neces- 
 sity always exist in certain business operations. Such monopolies 
 should be recognized as desirable and beneficial as their work 
 cannot be done equally well under competitive conditions; for 
 example, in the telephone business, the electric light and power 
 business, the surface railway, the gas or water-works business for 
 towns and villages, and even most cities. Where monopolies 
 are recognized as proper and permitted to exist, regulation of 
 rates by governmental authority follows almost as an axiom. 
 Monopolistic corporations are granted franchises, frequently 
 also, the right of eminent domain, they are given the use of the 
 streets and public highways, with other privileges entirely 
 unique and distinct, so that they may properly be held strictly 
 accountable to the public which has given them such endow- 
 ments. As their business is practically assured, free from com- 
 petition, as long as the service rendered is of first-class quality, 
 they are not entitled to charge unfair or exorbitant rates and 
 their earnings may properly be reduced to a fair return on the 
 vahio of their property being used for the service of the public.
 
 FUNDAMENTALS IN VALTWTTON 39 
 
 This condition holds, not only with regard to monopolies, that 
 may be formed in the future, but also with respect to those 
 already in existence, provided in fixing the return allowed the 
 latter corporations, consideration is given to the fact that they 
 created investments under more hazardous conditions than those 
 existing under a rate of return now considered fair. 
 
 In considering values found by appraisals for the purpose of 
 determining the fair rate of return to be allowed competing utili- 
 ties, such as steam railroads, there must also be recognized the 
 fundamental fact with regard to the existing tariffs, namely, that 
 tariffs between certain competing centers are absolutely the same 
 irrespective of the distance or the route, or the value of the prop- 
 erty used. In many instances, this equality of tariffs, regard- 
 less of distance, results from natural commercial conditions; for 
 example, the tariffs from New York to any one of a series of cities 
 on the Mississippi River is 125 per cent, of the tariff from New 
 York to Chicago, whether that city is practically west of Chicago, 
 or west of New Orleans. In the same way, shipments from Bos- 
 ton to Chicago might move via Asheville, N. C, over a route 
 1,786 miles in length, with the same charges, as over the direct 
 line only 1,004 miles in length.^ 
 
 These uniform tariffs are maintained in order, first, to prevent 
 rate wars, which would result in bankruptcy to the least favored 
 lines, and second, to permit the delivery of merchandise of 
 similar characteristics from widely divergent points to the com- 
 mon center, or vice versa. Thus it will be seen that, not from 
 choice, but because of economic reasons, the existing type of dis- 
 criminatory railroad tariffs have been built up and developed 
 and must be maintained to permit commerce to move freely in 
 every direction and to maintain markets at a parity, thereby 
 practically eliminating distance over wide areas for interstate 
 commerce. Under such conditions "regional rates" are properly 
 determined and fixed from a consideration of the value of the 
 various properties affected. 
 
 If rates are determined by the value of the railroad having the 
 least investment, what will become of the railroad with the large, 
 or perhaps excessive investment? On the other hand, if a fair 
 rate is allowed the railroad having the largest investment, the 
 line having the least investment will obtain unduly large profits 
 and be tempted to cut rates and thereby still further increase 
 
 ' Senate Committee, 1905 Digest, App. LL, page 10.
 
 40 VALUE FOR RATE-MAKING 
 
 its Ijusiness and earnings. Evidently, valuation alone, for com- 
 petitive railways, cannot be considered as a basis for fixing rates. 
 Other considerations must be the time required in rendering the 
 service, the quality of that service, the densit}^ and direction of 
 traffic, competition, the requirements of the isolated communi- 
 ties, along the lines of the respective railways and worth of the 
 service. 
 
 That competition between railroads, but also from that due to 
 water transportation, is a governing factor in fixing railroad rates, 
 regardless of the fair value of the property in service, has been 
 recognized by the Interstate Commerce Commission in more than 
 one case. 
 
 "First. — Is it true that the long-distance rate is forced by water 
 competition? The evidence in this case conclusively shows that wool 
 is transported from Pacific coast terminals to New York for not ex- 
 ceeding 65 cts. per 100 lb. It is plain that rail carriers could hardly 
 maintain a raU rate exceeding the present dollar charge. We find, 
 therefore, that water competition does force the rate of $1 from Pacific 
 coast terminals to the Atlantic seaboard. 
 
 Second. — Is the long-distance rate which has been established in view 
 of water competition less than would otherwise be reasonable? 
 
 Upon this point the finding must be that it is. This rate applies 
 for a distance of 3,000 miles, and we have held in this proceeding that 
 $1 would be a reasonable rate for a very much less distance over these 
 same lines."' 
 
 While competition may force such low rates as between steam 
 railroads for example as to prevent even a fair return on the 
 physical value of the property used in rendering the service, such 
 basis of return on the value of the physical property of utilities 
 generally, is usually not considered fair and adequate earnings. 
 
 The principles are very clearly discussed in the following extract 
 from the Commission reports, and the general statements not 
 only apply to rate-making for railroads, but also for monopolistic 
 utilities, such as electric light, gas and similar corporations: 
 
 "Is a rate unreasonable because it does not pay its full share of taxes, 
 fixed charges, and dividends? At the end this is the question to which 
 we come in this case. The carriers themselves having fixed these rates 
 under the mandate of the law that they shall fix just and reasonable 
 
 ' Opinion No. 1830 in the Matter of the Investigation of Alleged Unreasonable Rates and 
 Practices Involved in the Transportation of Wool, Hides, and Pelts from Various Western 
 Points of Origin to Eastern Destinations.
 
 FUNDAMENTALS IN VALUATION 41 
 
 rates, have they justified higlicr rates by showing tliat the existing 
 rates which they had fixed fall somewhat short of meeting all the related 
 expenses which the carrier must bear, not only for transportation but to 
 secure an adequate return upon its property? Let us see where this 
 doctrine would lead. If a carrier may raise all rates to a basis where 
 each will bear its share of cost, including all costs, and no lower rate is 
 reasonable, then it must follow that all rates are unreasonable which 
 yield to the carrier a greater return than such cost. Under such theory 
 what would be the rate on tea or silks, or high-priced horses, or delicate 
 machines? Is there to be no classification of freight excepting upon the 
 basis of cost of transportation plus insurance risk? If so the tariffs 
 of every railroad in the United States must suffer a revolutionary change. 
 In all classification consideration must be given to what may be termed 
 public policy, the advantage to the community of having some kinds of 
 freight carried at a less rate than other kinds. And this is the true 
 meaning of the phrase 'what the traffic will bear.' It expresses 
 the consideration that must be shown by the traffic manager to the 
 need of the people for certain commodities. He accordingly imposes a 
 higher rate upon what may be termed luxuries as compared with that 
 imposed upon those articles for which there is a more universal demand. 
 He also gives consideration to the fact that the rate so imposed enters 
 into the ultimate price to the consumer to but a small degree when the 
 article is one of high value, and that those in the community who can 
 afford to purchase such articles can well afford to pay a rate greater than 
 that which could reasonably be imposed upon the general public for 
 commodities of common use. In this sense what the traffic will bear 
 and the value of the service are analogous. No one would claim that a 
 carrier was violating its duty under the law in charging throe times the 
 rate upon oriental rugs that it imposed upon cotton. This would 
 not be undue discrimination as between commodities, even though it 
 costs no more to transport the rugs than it did the cotton, assuming 
 both to be carried at the owner's risk, for the one does not compete 
 with the other, and one may reasonably bear a higher rate than the other 
 upon pubhc grounds. It must be, therefore, that this Commission, under 
 the amendment to section 1 passed by Congress in 1910, giving to us 
 the control of freight classification, has power to determine the reason- 
 ableness of the differences that are made between the rates made 
 applicable to the various kinds of commodities transported. We may 
 not say that a rate shall be fixed so as to meet the requirements or 
 needs of any body of shippers in their efforts to reach a given market, 
 nor may we establish rates upon any articles so low that they will not 
 return out-of-pocket cost. Neither could we fix an entire schedule 
 of rates which would yield an inadequate return upon the fair value 
 of the property used in the service given. There is, however, a zone 
 within which we may properly exercise 'the flexible limit of judgment
 
 42 VALUE FOR RATE-MAKING 
 
 which belongs to the power to make rates.' These are the words of 
 the Chief Justice of the Supreme Court, 206 U. S. 126. There is no 
 flexible limit of judgment if all rates must be upon a level of cost, and 
 out of every dollar paid to the carrier must come a fixed amount of 
 return for capital invested. The recognition of such a doctrine has 
 never been suggested either by Congress or the Supreme Court. A just 
 and reasonable rate must be one which respects alike the carriers' 
 deserts and the character of the traffic. It cannot be a rate that takes 
 from the carrier a profit and thus favors the shipper at the carrier's 
 expense, nor is it one which compels the shipper to yield for the trans- 
 portation given a sum disproportionate either to the service given by 
 the carrier or to the service rendered to the shipper. The words 'just 
 and reasonable' imply the application of good judgment and fairness, 
 of common sense and a sense of justice to a given condition of facts. 
 They are not fixed, unalterable, mathematical terms. Their meaning 
 implied the exercise of judgment, and against the improper exercise of 
 that judgment the Constitution gives protection, at least as far as the 
 carriers are concerned."' 
 
 Purpose Affects Valuation. — Now, that the general public has 
 become interested in the subject of valuations, there is being 
 evolved a large amount of superficial, unscientific propaganda. 
 
 Although specialists in engineering, economics, accounting and 
 law, have been discussing and applying methods of valuation for 
 the past 15 years, or more, and although the State of Texas 
 made an appraisal of its steam railroads over 20 years ago the 
 relative amount of property appraised, compared with the total 
 investment in utilities throughout the United States, is com- 
 paratively small. In fact, there has been so much difference of 
 opinion between those having to do with the subject that at 
 present there cannot be said to be unanimous agreement, even on 
 the principles involved. 
 
 It is frequently claimed that the valuation of utility property 
 should be the same regardless of the use to be made of the valua- 
 tion. In a l)road sense this is true. A utility, however, may own 
 property, a portion of which is not used in rendering service to the 
 public and, while the value of the entire property could properly 
 be considered in a capitalization case, only the value of such 
 property as is used in the service rendered could be considered 
 in a rate case, so that the two reported values would be different 
 
 ' Report and Order of the Commission, No. 1806, page 623; In the matter of the investi- 
 gation and Huspension of advances in rates for the transportation of coal by the Chesapeake 
 & Ohio Itailway Company, Baltimore & Ohio Railroad Company, Norfolk & Western 
 Railway Company, the Kanawha & MichiKan Itailway Company, and their connections.
 
 FUNDAMENTALS IN VALUATION 43 
 
 depending on the use to be made of the vuhiation. Similarly, 
 the laws of many States indicate special valuations for purposes 
 of taxation, and these laws differ among the different States. 
 Consequently, in any valuation, the basis upon which it is to be 
 made and the way it is to be used must ])e considered. 
 
 "If it is decided that a public utility should be taxed on its total 
 value as a going concern — that is, its commercial, market or sale value — 
 then franchise and going value will be included. If, on the other hand, 
 the public-utility plant is to be taxed precisely as otlier real estate, the 
 cost of reproduction less depreciation will be the basis. There is no 
 inherent inconsistency in using one method of valuation for tax purposes 
 and another method for rate purposes." 
 
 "Different methods of estimating the value of property may properly 
 be employed when it is valued for different purposes."^ 
 
 It is unquestionably true that a valuation determined solely 
 with reference to the specific case and particular purpose for 
 which the valuation is necessary, alone meets the condition, 
 "fair value." The courts have recognized the truth and reason- 
 ableness of this statement and they have rendered decisions hav- 
 ing in mind whether the valuation is for purposes of purchase and 
 sale, or taxation, or rate-making, or capitalization. It may 
 happen that the fair value will be found to be the same for one 
 purpose as another, but not necessarily so. 
 
 "It appears to us that considerable confusion in the discussion of the 
 subject of valuation* * * arises from a confusion of the terms 'cost' 
 and 'value.' Cost is a definite amount regardless of purpose. The 
 actual cost and the reproduction cost of any structure may be deter- 
 mined without reference to the purpose for which such estimates may 
 later be used. This is what is often meant when it is said that valuation 
 should be the same regardless of purpose. All that is really intended 
 is that actual cost or reproduction cost should be the same. But cost 
 is not necessarily value for any purpose, though it is an element in 
 estimating fair value for almost any purpose. Thus fair value for rate 
 purposes may be based largely on actual cost or on reproduction cost, 
 or on a composite of actual cost, and reproduction cost.'"'^ 
 
 Value for rate-making can seldom, if ever, properly be used as 
 the value in the case of purchase and sale. If, in the latter case, 
 
 I Ex-Commissioner M. Basset, National Association of Railway Commissioners, Wash- 
 ington, D. C, Oct. 10-13, 1911. 
 
 ^ Proceedings of the 23rd Annual Convention; page 145, October, 1911; National Associa- 
 tion of Railway Commissioners.
 
 44 VALUE FOR RATE-MAKING 
 
 there was included with the title to property transferred, a cash 
 reserve fund equal in amount to the difference between the 
 present depreciated value of the property and its cost of reproduc- 
 tion new, then only in such case would the sales value be the same 
 fair value that properly should be used for rate-fixing purposes. 
 It is possible that in the future, under Public Service Regulation, 
 accumulated reserve funds, corresponding to the total amount of 
 estimated depreciation on the property may be held to be a part 
 of the property but usually, under existing conditions, the 
 purchaser of utility property must assume the obligations to 
 make good, in the future, all accruing depreciation, to cover 
 which few existing utilities have sufficient reserve funds in hand. 
 
 For purposes of capitalization, there must usually be allowed 
 an appreciably larger value for the par value of securities than 
 the valuation of the physical property plus all intangible charges, 
 due to the fact that bonds are almost always sold below par 
 value; in some States, stock is legally so sold. 
 
 It is true that in some instances, the courts, even the Supreme 
 Court, have implied that a lower value is properly allowable for 
 purpose of rate-making than in case of sale, but the more recent 
 rulings do not seem to sustain that view. As a matter of 
 common sense, the reverse of such ruling would more nearly ac- 
 cord with common practice and experience. No investor will 
 pay a higher price for a property than that upon which he will be 
 allowed to make earnings present and prospective. If such 
 earnings or rate of return is fixed by the courts at 5 per cent., for 
 example, on the appraised fair value of the property, when 
 money is earning 6 per cent., the price the investor will pay for 
 such property is less than fair value as determined by valuation; 
 consequently, the sale price to any intelligent buyer will never be 
 larger than the value allowed for rate-making. In this connection 
 attention should be called to the anomalous position that has 
 been taken by courts in holding — very {)roperly — that utility 
 corporations must even against their wishes, make extensions 
 and additions to keep up to and meet the demands of the public 
 but, nevertheless — it would seem very improperly — refusing, as 
 the Supreme Court has done, to protect the utilities against 
 reduction in rate as long as the earnings are sufficient to provide 
 merely a "fair return" upon their property, which must be taken 
 to include such extensions as have been ordered. When "fair 
 return" is held to be practically 6 per cent, as in the Consolidated
 
 FUNDAMENTALS IN VALUATION 45 
 
 Gas Co. case and only 4>^ per cent. ( 6 per cent, less 1)^ per cent, 
 to cover estimated depreciation) as in the Knoxville Water Co. 
 case, free capital cannot ordinarily be induced to invest, and 
 additional capital is only obtained on such basis by corporations 
 existing under the most favorable conditions or because they are 
 able to offer preferred securities. Either of these bases, however, 
 cannot be considered a fair and proper basis upon which to fix a 
 fair rate of return for the ordinary property, or the entire value of 
 utility property. 
 
 Value for rate-making will result in a different amount than 
 value for sale or for taxation. Abstractly the value of the same 
 items must be the same, but the purpose supplies the adjective 
 which modifies the final result. 
 
 It is inconsistent to include in the value for taxation the in- 
 tangible property of utilities when the value of other property 
 excludes the same or similar intangibles. Again there may be 
 fundamental differences between public utilities and industrial 
 corporations; for example, in the former the total revenue may be 
 but one-fifth the value of the property upon which taxes are 
 assessed, while with the latter class, the revenue may be five or 
 more times the value of the assessed property resulting in taking 
 from each dollar of revenue of the utility twenty-five times the 
 amount taken from that of the industrial corporation. If 
 under-valuation for purposes of taxation is permitted for other 
 property, utility property should be similarly equalized. 
 
 In the matter of value for purpose of taxation, conflicting 
 decisions have been made; for example, the County Assessor of 
 Salt Lake County, Utah, held in the case of the Bingham & 
 Garfield Railroad that although the road had a considerably 
 larger revenue, was a costly one to build, on account of difficult 
 engineering problems, and while on the basis of either reproduc- 
 tion or investment cost the value of the property would be very 
 much higher than the Bingham Branch of the Denver & Rio 
 Grande Railroad, nevertheless, that was no reason why the 
 former road should be required to pay more than its share of 
 taxation, as both roads were operated between the same points 
 and doing similar business at the same rates. 
 
 On the other hand, Judge Williard of the United States Court, 
 sitting in S. Dakota, held in one case with certain express com- 
 panies as to the value of their property set up as a basis of taxa- 
 tion, but in a second and later rate case indicated that any
 
 46 VALUE FOR HATE-MAKING 
 
 attempt to increase the tax values previously established, for the 
 purpose of rate-making, was an attempt to trifle with the Court, 
 concluding that the values set forth at the tax hearing must 
 govern in both cases. 
 
 Thus it will be seen, except in the last case cited, the term 
 value has different meanings in connection with public utility 
 properties, the same as in ordinary commercial business. As 
 steel has no value for food purposes or wheat as structural 
 material, their value depending upon the use to which they are 
 put, so the value of utility property depends upon its use; the 
 purpose of the valuation must ultimately determine the value. 
 
 "We are dealing, not with exchange values, but with the value upon 
 which the Company is entitled to earn a return."^ 
 
 Gifts and Donations. — The Constitution of the United States, 
 by the Fifth Amendment, provides: 
 
 "That no property shall be taken for public use without just com- 
 pensation." 
 
 and by the Fourteenth Amendment: 
 
 "That all persons shall be entitled to equal protection of the laws." 
 
 These rights must be respected by the United States Government 
 itself as well as by the State legislatures and all public authorities 
 or courts. It makes no difference whether the rightful owner has 
 purchased or been given his property, neither the whole of it 
 nor any part of it can be transferred or taken without just com- 
 pensation. It is immaterial whether the property has been paid 
 for out of earnings or has appreciated in value. It makes no 
 difference whether controlled by private individuals or owned 
 by corporations, it cannot be confiscated despite any act of 
 Congress or other legislative body. If the value of the property 
 used must be considered in determining rates, the fixing of rates 
 based on a value of the property which excludes any portion 
 of the whole property because it may have been donated, paid 
 for out of just dividends or accrues from appreciation in land, 
 results in confiscation, takes from the value of the property 
 owned, and is therefore illegal. 
 
 "These cases all support the proposition that while it is not the prov- 
 ince of the courts to enter upon the merelj'^ administrative duty of 
 
 ' Judge Miller of N. Y. Court of Appeals — People ex rel Kings Co. Lighting Co. vs. 
 Wilcox et nl, 210 N. Y. 479.
 
 FUNDAMENTALS IN VALUATION 47 
 
 framing a tariff of rates for carriage, it is within the scope of judicial 
 power and a part of judicial duty to restrain anything wliich, in the 
 form of a regulation of rates, operates to deny to the owners of property 
 invested in the business of transportation that equal protection which is 
 the constitutional right of all owners of other property. There is 
 nothing new or strange in this. It has always been a part of the judicial 
 function to determine whether the act of one party (whether that party 
 be a single individual, an organized body or the public as a whole) 
 operates to divest the other party of any rights of person or property. 
 In every constitution is the guarantee against the taking of private 
 property for public purposes without just compensation. The equal 
 protection of the laws, which, by the Fourteenth Amendment, no State 
 can deny to the individual, forbids legislation, in whatever form it may 
 be enacted, by which the property of one individual is without com- 
 pensation wrested from him for the benefit of another, or of the public. 
 This, as has been often observed, is a government of law and not a 
 government of men, and it must never be forgotten that under such a 
 government with its constitutional limitations and guarantees the forms 
 of law and the machinery of government, with all their reach and power, 
 must in their actual workings stop on the hither side of the unnecessary 
 and uncompensated taking or destruction of any private property 
 legally acquired and legally held."^ 
 
 The Supreme Court of the United States, as recently as last 
 June, rendered a very important decision reaffirming its earlier 
 decisions to the effect that property owned by a utility belongs 
 to it, regardless of the fact that it was donated. The case 
 arose through the attempt of the Federal Government to compel 
 forfeiture of the unsold portion of the Oregon & California 
 Railroad land grant amounting to 2,300,000 acres, valued at 
 more than $30,000,000. In its suit the Government charged 
 that the railroad company had forfeited its rights by having 
 violated a provision which required it to sell in not more than 
 160-acre tracts at a price not exceeding $2.50 an acre, and only 
 to actual settlers. The Government sought to prove that the 
 company had sold in large tracts to timber companies at more 
 than $2.50 an acre, and had adopted a poHcy to sell no more to 
 any purchaser for the time being. The railroad company 
 contended that the provision was not effective because the 
 lands were unfit for settlement, and furthermore urged that 
 the Government could not raise the question of forfeiture be- 
 cause of long acquiescence in the company's disregard of the 
 
 1 Reagan vs. The Farmers' Loan &. Trust Company, 154 U. S. 302.
 
 48 VALUE FOR RATE-MAKING 
 
 selling provision. Judge McKenna, writing the opinion, said 
 that the Government's position, in claiming that the conditions 
 of the grant regarding sales were conditions for which a viola- 
 tion worked a forfeiture, was untenable. The Court held that 
 the conditions were in the nature of "enforceable covenants," 
 and that the Government could not cancel the railroad com- 
 pany's grant. The Court, however, enjoined for a six-month 
 period the railroad company from future sales in violation of 
 the conditions of the grant, so that Congress would have a 
 reasonable time in which to act. 
 
 Free Service. — Public utilities have frequently been obliged 
 to agree to render "free service" in the form of transportation, 
 lighting, telephone service or power, for which no direct charge 
 is made. The consideration for such "free service" is usually 
 a franchise right to use the public streets or highways, or some 
 other concession assumed to be an equivalent of the service 
 rendered. Of course, such "free service" is not without ex- 
 pense and charge to someone. Where the utilities were allowed 
 to make their own tariffs and charges for service, the gratuitous 
 rendition of a limited amount of service may have come out of 
 the net earnings of the utility itself, and in that way the public, 
 or its agents, were benefited. More usually, however, the 
 granting of favors or "free service" by the utility, resulted in 
 failure to exact all that otherwise might properly be asked 
 of the utility, and thereby the public became the real loser. 
 Under public utility regulation, the cost of "free service" is 
 included with the other expenses which go to make up the total 
 costs of service, so that no real advantage accrues to the public 
 as the rates established will be less in case no "free service" is 
 rendered than when the cost of the "free service" is added and 
 included in fixing tariffs sufficiently high to include these costs. 
 Consequently, the whole question is as broad as long, and there 
 is no advantage in taking money out of one pocket and putting 
 it into another, particularly as such process results in involved 
 questions and increased difficulties of ascertaining proper 
 operating costs. 
 
 The general tendency of public service regulating bodies has 
 been to abrogate any obligation on the part of utilities to furnish 
 "free service," even though franchises or contracts so provide. 
 This attitude and action of public authorities has been passed 
 upon and approved by the courts. The legal authorities have
 
 FUNDAMENTALS IN VALUATION 49 
 
 frequently ruled upon the right of the legislature to even abrogate 
 contracts made by municipalities, so that public commissions, the 
 creature of, and acting for the legislatures, undoul)tedly can 
 abrogate contracts or franchise agreements between nninici- 
 palities and corporations, when the latter consent to such 
 abrogation. 
 
 In the case of the City of Worcester against the Worcester 
 Consolidated Street Railway Company (see also page 4), the 
 Court passed on the question of whether the company could 
 be compelled, under the clause in its franchise, to pave streets, 
 and the Court assumed that a definite contract did exist between 
 the City and the company, but that, nevertheless, the Legislature, 
 in the exercise of its general legislative power, could a))rogate 
 such contract, saying: 
 
 "A municipal corporation is simply a subdivision of the State." 
 "If these restrictions or conditions are to be regarded as a contract, 
 we think the Legislature would have the same right to terminate it, 
 with the consent of the Railroad Company, that the City itself would 
 have."^ 
 
 The above position has been recently affirmed by the 
 New Jersey Court in a very similar case. The Public Service 
 Electric Company of New Jersey, or its predecessor, had entered 
 into a specific contract with the City of Plainfield, N. J., for the 
 use of the city streets for its poles and wires, in return for which 
 the company agreed to 
 
 "light by electricity, free of charge, certain municipal buildings, offices 
 and rooms, owned or occupied by the City officers," etc. 
 
 The company performed its part of the contract from 1898 
 until 1913, over 15 years; then the company refused to continue 
 to furnish free light, pleading that the Public Utility Law of 
 New Jersey prohibited discrimination and therefore the company 
 was precluded from carrying out its contract by the statute of 
 the Legislature. The Board of Utility Commissioners of 
 Plainfield made an order directing the company to furnish lights 
 in accordance with its contract, but the company applied to the 
 Court, and the Court rendered a decision, speaking as follows: 
 
 "We think, however, that the Pubhc Utilities Act, in forbidding 
 discrimination, made the performance of this contract unlawful, and 
 
 J 196 U. S. 552. 
 4
 
 50 VALUE FOR RATE-MAKIXG 
 
 that, therefore, the prosecutor (the company) could not continue to 
 perform the contract without being guilt\' of viohition of that statute."' 
 
 The Local Board contended that the furnishing of free lights 
 to the City was not discrimination, but the Court said: 
 
 "No other evidence is required or necessary than is furnished by the 
 contract to demonstrate that the preference or advantage given ))}' the 
 contract is undue and unreasonable and within the violation of the 
 Public Utilities Act. The fact that there was such undue and unrea- 
 sonable preference or advantage given, is sufficient basis to set aside 
 the order made by the Public Utilities Commissioners.' '^ 
 
 Agency Theory. — The "original cost" basis of valuation has 
 been used by those advocating the theory that the property of a 
 public utility belongs really to the public and that the owners are 
 merely the trustees or agents of the public. This theory has been 
 developed and advocated perhaps most strongly by some mem- 
 bers of the Railroad Commission of the State of California. In 
 the recent Antioch decision of the California Commission the 
 fundamental principles involved in determining the basis on 
 which return should be allowed were discussed at length. The 
 Commission brushed aside as without warrant the contention 
 of the utility that the basis for fixing rates should be reproduc- 
 tion value new of the company's physical plant plus an allowance 
 for going value. The Commission argued that a utility is entitled 
 to a reasonable return upon money honestly and wisely expended 
 for the public, but that loss due to abnormal conditions, bad man- 
 agement, poor judgment, and lack of ordinary care and foresight 
 must be borne by the utility and not by the public. In develop- 
 ing this phase of the subject, Commissioner Thelen who wrote 
 the opinion, suggested, that in many respects the relation between 
 utility and its consumers may be compared to that existing be- 
 tween principal and agent. While the Cominission, in rendering 
 its final decision, accepted the conclusions of Commissioner 
 Thelen, as to values, the president of the Commission, Mr. John M. 
 Eshleman, dissented from his fellow commissioner and character- 
 ized this doctrine of agency as dangerous, stating that the 
 Supreme Court would not countenance any finding to the effect 
 that owners of a public utility hold such property as agents. His 
 exact language is as follows: 
 
 • Public Service Electric Company vs. Board of Utility Commissioners, of City of Plainfield, 
 93 Atlantic 708.
 
 FUNDAMENTALS IN VALUATION nl 
 
 "Tlie main reason then why I do not accept the able reasoning of 
 Mr. Thelen in this regard is that it wiU merely serve longer to keep us 
 lulled to sleep until all our valuable public stores and privileges shall 
 have been given away, when we shall awaken to the painful fact that 
 they are no longer ours, just as we are now made to know that the 
 waters of our rivers and streams, incalculable in value, are for nothing 
 the prize of the alert private interest merely because public authority 
 slept. 
 
 "The authorities cited do not at all convince me that the Supreme 
 Court will ever hold, when the matter is directly before it, that the 
 owners of a public utility property hold such property as an agent at 
 all. In fact that Court has in several well-considered cases definitely 
 decided that such is not its view. Therefore, if we are to escape ex- 
 cessive unearned increments and rates based upon the gift we have 
 made, it must be on some other theory than that the owner of public 
 utility property is in any proper sense, as to such property, an agent." 
 ******** 
 
 "If legal, as I am sure it is not, it works beautifully as to those 
 agencies that are now subject to regulation, but it fails as to other agen- 
 cies that shall hereafter engage in business which, but for this, would 
 be subject to regulation. The recent case of the Del Mar Light, Water 
 and Power Company against this Commission indicates the danger to 
 regulation of urging this doctrine. A public utility business is no different 
 from any other business, except that it occupies such a position in 
 society by reason of its monopolistic character that the State, under its 
 police power, may regulate it both as to the price for which and those 
 to whom it shall accord its service."^ 
 
 Certain utility commissioners, however, are not the only 
 individuals holding that utility property really belongs to the 
 public. Dr. Justice Van Fleet comes out very squarely in favor 
 of this theory in a decision recently rendered in the San Diego 
 Water Company case, where he said: 
 
 "As we have said, it is not the water or the distributing works which 
 the company may be said to own, and the value of which is to be as- 
 certained. They were acquired and contributed for the use of the 
 public; the public may be said to be the real owner and the company 
 only the agency of the public to administer their use."^ 
 
 The above expression of opinion has been approved by 
 Commissioner Thelen in the North Coast Water Company casc.^ 
 
 1 Town of Antioch vs. Pacific Gas & Electric Company. Case No. 400; decided July 6, 
 1914. 
 
 * San Diego Water Company vs. San Diego, 118 Cal. 556, page 570. 
 
 ^Decision No. 1110 in the matter of the application of North Coast Water Co., for 
 authority to increase the rates for water charged to Belvedere Land Co.
 
 52 VALUE FOR RATE-MAKING 
 
 The agency theory is a comparatively recent one and it indi- 
 cates the tendency of the times and a willingness on the part of 
 the public to depress the value of corporation property without 
 paying the present value therefor. The legal relation between 
 agent and principal always has been that the agent represents the 
 principal, but the latter is responsible. If the utility investors 
 were merely agents, the public as principal would be responsible 
 for operation and management with resulting profits or losses. 
 
 Apparently anticipating the future claim that owners of prop- 
 erty used in the service of the public were merely agents, the 
 Federal Court years ago held that "the property now under 
 consideration (of the gas company) is as much the private 
 property of this complainant as are the belongings of any 
 private citizen."^ 
 
 The fact that the investor is compelled to assume the loss in 
 case of an unprofitable venture must be considered in fixing the 
 fair rate of return of profitable utilities. That rates cannot be 
 advanced sufficiently to always make a return even on the value 
 of the physical property is well illustrated by the decision of the 
 Railroad Commission of Oregon in the Home Telephone & 
 Telegraph Company case, where the decision says: 
 
 "If the Commission should grant authority for the Home Company 
 to increase its rate to the extent prayed in its original or amended 
 applications, the Home Company would lose a large number of sub- 
 scribers who are now patrons of its exchanges, without gaining any 
 subscribers in place thereof, and the effect would be to decrease the 
 number of subscribers connected, to diminish the value of service to 
 the existing subscribers and not to increase the gross or net revenues 
 of the company in proportion with the increasing rates. It is not 
 possible, either by the schedule of rates applied for or by any other 
 schedule which the commission can name, to yield to the company its 
 present and duly high operating expenses, its taxes, depreciation and 
 any substantial return upon the investment, for the reason that any 
 rates which would yield such return would be so large that the same 
 would exceed the value of the service to the patrons and would be un- 
 reasonably high, and the applicant would in consequence lose so many 
 subscribers that neither its gross nor net revenues would be increased. "^ 
 
 It is not clear by what process an impartial, judicial mind can 
 reason that properties which have been constructed and paid for 
 
 ' Consolidated Gas Co. vs. N. Y., 157 Fed. 854 
 ^ Commission files L. U. F. 52-54,
 
 FUNDAMENTALS IN VAIAJATION 58 
 
 by a corporation and arc used in serving the i)ul)lic bcloii^r 
 to the owners as "only the agent of the pubHc to achniiiislcr 
 their use." Certain it is that as yet the majority of the piiljlic 
 and the higher courts are not prepared to decide that projxTty 
 used in the service of the pubHc, paid for by the money of private 
 individuals, belongs to the public and administration and opera- 
 tion are the only rights the owners have in such property. 
 
 "The 'trustee theory,' so-called, assumes that there exists between 
 the public and every railroad carrier the relation of principal and agent, 
 or of beneficiary and trustee. No such relation exists and the assump- 
 tion is without any foundation or support." 
 
 "The right of governmental authority to regulate charges of those 
 engaged in public calling, or to regulate the selling price of commodities 
 — in the cases where such prices may be regulated — rests upon the power 
 of police and not upon ownership, legal or equitable, of the property. 
 
 "There is no support in judicial decisions for the trustee theory, or 
 for the idea that the power to regulate in any manner impairs or lessens 
 the title or ownership of him, whose charges or prices are subject to 
 regulation, for the protection of the public against extortion and unfair 
 competition."^ 
 
 1 Brief filed on behalf of the Railroad Companies represented by the Presidents' Con- 
 ference Committee before the Interstate Commerce Commission, Sept. 1, 1915.
 
 CHAPTER IV 
 FAIR VALUE FOR RATE-MAKING 
 
 Principles Involved. — There has been a steady and remarkable 
 increase in the use of utiUty service which was formerly con- 
 sidered more or less a luxury, for example, the general use of 
 gas, electric light, telephone, street car service, etc. This has 
 continued until the general public, now looking upon such ser- 
 vice as an ordinary necessity, is largely interested in the ques- 
 tion of charges for the service rendered and whether or not 
 these charges are fair and proper. Owing to the intricacies of 
 utility management, various methods of accounting and the 
 man}' elements entering into the costs of service, the public 
 generally does not appreciate the varied and necessary indirect 
 expenses, or realize that many charges must be deferred and, 
 therefore, are not apparent in the current weekly or monthly 
 expenditures. 
 
 The public is primarily interested in the rendering of efficient, 
 high-class service by every utility, and efficiency, progressiveness 
 and permanency cannot be obtained, except by proper recogni- 
 tion and allowance, both of the fair value of the investment and 
 fair return or profits thereon. Merely, "just" reward will not 
 usually accomplish these results; the Constitution of the United 
 States guarantees " nor shall private property be taken for private 
 use without just compensation," but mere "just compensation" 
 without something additional in the way of reward, or extra 
 compensation, does not always insure satisfactory utility service 
 and development. This is recognized by the courts and evi- 
 denced by the commissions in allowance by the latter of higher 
 rates of return than the mere legal requirement. The restriction 
 of reward or profit to that securable from most certain and con- 
 servative business ventures, or to the minimum that will be 
 allowed by the Supreme Court in order to avoid confiscation, 
 eliminates all incentive to risk and achievement which have 
 always been the spurs to individual initiation, invention and 
 enterprise, that are the boast of our modern civilization. 
 
 54
 
 FAIR VALVE FOR RATE-MAKING 
 
 Public regulating bodies usually require a valuation of tlic 
 physical property before undertaking rate-making. While this 
 is natural and very often necessary in order to base conclusions 
 upon actual figures, it is an interesting fact that some com- 
 missions have not required such valuation for rate-making 
 purposes and have held that it is practicaljle to base rates upon 
 information obtained from annual reports, examination of books 
 and property, and a knowledge of the general condition of the 
 utility being considered. In fact, mathematical exactness can- 
 not be followed in working out the rates to be charged for 
 services, even where a detailed valuation has been made; the 
 valuation at best can only be used in determining an approxi- 
 mate amount of revenue which the utility is entitled to receive 
 as a fair return upon its property. 
 
 We hear a great deal about rates being based upon the "cost- 
 of-service" and " value-of-service " theory, but these bases of 
 rates have to do mainly with apportioning the tariffs for ser\dces 
 rendered, and have little to do, ordinarily, with the question 
 of total revenue, which must be earned in order to yield the 
 utility a fair return upon the value of its property. In fixing 
 individual tariffs for each class of service, the maximum antl 
 minimum to be allowed are considered, but the total revenue from 
 all classes of service at the different tariffs is what must be 
 considered in connection with the value entitled to fair return. 
 
 "Is a rate unreasonable because it does not pay its full share of 
 taxes, fixed charges, and dividends? ****** if a carrier may 
 raise all rates to a basis where each will bear its share of cost, including 
 all costs, and no lower rate is reasonable, then it must follow that all 
 rates are unreasonable which yield to the carrier a greater return than 
 such cost. Under such theory what would be the rate on tea or silks, 
 or high-priced horses, or delicate machines? Is there to be no classi- 
 fication of freight excepting upon the basis of cost of transportation 
 plus insurance risk? If so the tariffs of every railroad in the United 
 States must suffer a revolutionary change. In all classification con- 
 sideration must be given to what may be termed public policy, the 
 advantage to the community of having some kinds of freight carried 
 at a less rate than other kinds. And this is the true meaning of the 
 phrase 'what the traffic will bear.' It expresses the consideration that 
 must be shown by the traffic manager to the need of the people for 
 certain commodities. He accordingly imposes a higher rate upon what 
 may be termed luxuries as compared with that imposed upon those 
 articles for which there is a more universal demand. He also gives
 
 56 VALUE FOR RATE-MAKING 
 
 consideration to the fact that the rate so imposed enters into the ulti- 
 mate price to the consumer to but a small degree when the article is 
 one of high value, and that those in the community who can afford 
 to purchase such articles can well afford to pay a rate greater than 
 that which could reasonably be imposed upon the general public for 
 commodities of common use. In this sense what the traffic will bear 
 and the value of the service are analogous. No one would claim that 
 a carrier was violating its duty under the law in charging three times 
 the rate upon oriental rugs that it imposed upon cotton. This would 
 not be undue discrimination as between commodities, even though it 
 costs no more to transport the rugs than it did the cotton, assuming 
 both to be carried at the owner's risk, for the one does not compete with 
 the other, and one may reasonably bear a higher rate than the other 
 upon public grounds."^ 
 
 Only general principles that should be adopted in deter- 
 mining the fair value of the property used, useful or reasonably 
 necessary for the service being rendered, have been enunciated 
 by the Supreme Court, Definite and determinate rules for 
 valuing property have been established by some of the lower 
 courts, as well as State commissions, and through the approval 
 or disapproval of these decisions and rulings the Supreme Court 
 may be said to have directly determined certain proper methods 
 to be pursued in valuing public service property. 
 
 In the valuation of a utility property in Maine, there were 
 referred to the Supreme Court of Maine, under a statute of that 
 state, questions to be answered as a guide to the appraisers who 
 were engaged in valuing the property of the water company 
 for the purpose of acquisition by a water district. The in- 
 structions of the Court are so illuminating that they are briefly 
 summarized as follows: 
 
 The Court held that the actual cost of the plant, with a 
 proper allowance for depreciation, was competent evidence on 
 the question of value, but was not conclusive. 
 
 That the earnings of the company might be considered, but 
 would not furnish a proper test of value, unless found to have 
 been reasonable. 
 
 That the quality of \hc water and service rendered and the 
 
 ' Report and Order of the Interstate Commerce Commission, No. 1806, pape C23; in the 
 matter of the investiKation and suspension of advances in rates for the transportation of 
 coal by the Chesapeake & Ohio Railway Company, Baltimore & Ohio Railroad Company, 
 Norfolk & Western Railway Company, the Kanawha & Michigan Railway Company, 
 and their connections.
 
 FAIR VALUE FOR RATE-MAKING 57 
 
 fitness of the plant to meet reasonable requirements were material 
 upon the question of present value. 
 
 That the appraisers should regard the franchises of the com- 
 pany as entitling them to continue business as a going concern, 
 but subject to all proper legal duties governing public service 
 corporations. 
 
 That, 
 "in fixing the value of the companies' franchises, the appraisers may 
 give such regard as is demanded by ample and fair pubHc policy to 
 the past investment, risks and services of the companies, and to the 
 reasonably just expectations which those who made the investment 
 had in mind when so investing. "^ 
 
 That past misconduct or unfaithfulness on the part of the 
 companies in performing their duties to the public, as by charg- 
 ing excessive rates, should not be considered on the question of 
 the value of franchises. 
 
 That reproduction cost was properly to be considered, but that 
 such cost was not conclusive because it left out of consideration 
 the element of value as a completed structure, connected with 
 buildings prepared for use, and the element that the company 
 was a going concern, and that these latter elements were to be 
 taken into consideration. 
 
 That, 
 "in determining the amount to be added to structure value, in consid- 
 eration of the fact that the system is a going concern, the appraisers 
 should consider, among other things, the present efficiency of the 
 system, the length of time necessary to construct the same de novo, 
 the time and cost needed after construction to develop such new sys- 
 tem to the level of the present one in respect to business and income, 
 and the added net income and profits, if any, which by its acquire- 
 ment as such going concern would accrue to the purchaser during the 
 time required for such new construction for and such development of 
 business and income."^ 
 
 The two fundamental facts to be established in rate-making 
 are the present value of the property being considered and the 
 rate of return to be allowed thereon. To reach fair and equitable 
 conclusions as to these facts to be established involves difficulties 
 not alone because the facts must be fixed as a matter of judgment, 
 but because the subject must be approached in fairness, equity 
 and without prejudice to the conflicting interests involved. 
 
 1 Kennebec Water District vs. City of Waterville, 54 Atl. (Me.) 6.
 
 58 VALUE FOR RATE-MAKING 
 
 In attempting to follow the legal method of making an 
 appraisal to arrive at the fair value for rate-fixing purposes, 
 original investment or cost must usually give way to reproduc- 
 tion value, unless precluded by State laws or other contractural 
 relations. It sometimes happens that rules and regulations fixed 
 by legislatures and commissions or court decisions render futile 
 the fixing of what is really fair present value, but that by no 
 means prevents the ascertainment and presentation of the basis 
 of fair value, although such basis may be ultimately discarded. 
 
 In rate-fixing, it must be constantly borne in mind that the 
 problems to be solved are the fair revenue allowed a particular 
 property on the basis of its value at the present time. This 
 value cannot be ascertained merely by reference to its past 
 history, even as to earnings or cost, unless such limits were fixed 
 at the time of its creation. Whether earnings were so small in 
 the past as not to have allowed ample return to the owners, or 
 whether the earnings have been sufficiently great to permit 
 payment of profits, as well as additions to and enlargements of 
 the property itself, cannot be used to justify the use of any 
 fictitious value or artificial rate of return in disregard of the real 
 present value and fair return as between the owners and the 
 rate payers. In attempting to ascertain the present value of the 
 property, the appraiser must approach the question without bias 
 of favoritism, considering only what a fair, business-like invest- 
 ment under existing circumstances, with normal conditions of 
 construction and financing, would be required. The same funda- 
 mental principles must apply regardless of whether the property 
 might be owned by an individual, a corporation, a municipality 
 or the Federal Government, although the cost might be, and the 
 rate of return allowed certainly would be, different with respect 
 to the four different classes of owners indicated for purposes of 
 illustration. 
 
 The valuation of public utilities for the purpose of rate-making 
 requires the knowledge and skill of engineers, real estate ap- 
 praisers, accountants and economists, financiers and lawyers. 
 Otherwise, the proper importance of the many elements of the 
 value going to make up the total fair value of the entire property 
 will not be appreciated' and duly recognized. The early at- 
 tempts of accoimtants and lawyers to demonstrate to courts 
 the value of property to be used as a basis for sale, condemna- 
 tion, or rate-making resulted in frequent failure. Later, the
 
 FAIR VALUE FOR RATE-MAKING 59 
 
 introduction of the engineer, who had had experience in opera- 
 tion as well as construction work, emphasized the relation of 
 the physical to certain non-physical elements, hut there was 
 still lacking knowledge and recognition of many of the intangil^le 
 elements, to demonstrate the causes and value of which were 
 required the services of those expert in utility operation, in 
 economics and finance. 
 
 "When * * * appraisals first came to be used as a basis for rate regu- 
 lation all, except engineers, regarded an appraisal as being soniewliat 
 analogous to a merchant's inventory of stock on hand — a very simj)le, 
 though often laborious, process. Gradually it has become evident, even 
 to non-technical men, that an appraisal for rate-making purposes is ex- 
 ceedingly technical and complex. When it is realized, also, that rate- 
 making based on cost is even more technical than appraising a property, 
 we shall have an end to the 'hot air' testimony of rate experts wlio are 
 experts only in fixing rates as high 'as the traffic will bear.' 
 
 Appraisal and rate engineering has already become one of the many 
 branches of engineering. The engineering specialist in this line should 
 be primarily a logician, skilled in the use of language and in the .science 
 of reasoning. He should be thoroughly acquainted with tlie general 
 principles of economics and particularly with the principles of engineer- 
 ing economics. He should be well informed as to the decisions of State 
 and Federal rate-regulating commissions, as well as court decisions 
 bearing on valuations and rates. He should be personally acquainted 
 with specialists in many lines, so that he may select men competent 
 to give any desired information. He should be thoroughly grounded, 
 not only in the principles of accounting, but in the mechanical details 
 of public utility accounting. He should be an incessant student of the 
 new phases of his specialty and of unit costs of construction and operation. 
 Executive ability is also essential to him, but need not be of as high 
 an order as that required of one who is constantly directing large enter- 
 prises. It is needless, perhaps, to add that his character should be such 
 that he would make an impartial judge. Obviously, no man can attain 
 the ideal in this or in any other branch of engineering; but, at least, 
 those who employ appraisal and rate engineers should aim to secure 
 men who are idealists rather than opportunists, for this is not a profes- 
 sion where mere advocates will survive."' 
 
 In ascertaining the value of any property, new or old, the 
 valuation of all of its physical or structural property is generally 
 conceded as the first step proper to be taken. While agreement 
 
 » By H. p. Gillete, Discussion on Physical Valuation of Railroads, Proceedings of tho 
 American Society of Civil Engineers, Vol. XXXIX, No. 8.
 
 60 VALUE FOR RATE-MAKING 
 
 may be had as to the inventory or Hst of items going to make up 
 the total property, differences begin to arise as soon as assign- 
 ment of value in dollars begins. This difference widens as per- 
 centages or estimated amounts are added for allowances, gen- 
 erally conceded necessary, to cover items too small to list 
 separately, incidentals, omission due to inaccuracy, unrecognized 
 contingencies of construction, engineering, administration ex- 
 penses, cost of contractors' services and expenses, insurance, taxes, 
 interest, cost of raising money, reward to the originators of the 
 enterprise for services and expenditures before construction 
 began, and other so-called overhead or intangible costs. Then 
 there are the further differences as to the proper treatment of 
 certain items such as real estate, the cost of developing the 
 revenue as distinct from building the physical property, usually 
 called "going value," the necessary allowances for working 
 capital, and finally the application of depreciation, in order to 
 obtain the so-called depreciated present value. 
 
 Even those advocates of the theory that only physical values, 
 theoretically depreciated, should be considered in rate-making 
 generally admit the fact that in addition to the actual net cost 
 of the structural property there should be added certain allow- 
 ances, more or less liberal, for all of those items mentioned 
 above except going value. They may hold that real estate 
 should be taken at its original cost, that working capital consists 
 only of supplies and going value has no existence but, otherwise, 
 they admit that after depreciation has been deducted from 
 structural value, built upon such meager basis as here indicated, 
 the remainder is the fair present value of any utility property. 
 
 Law and Method. — In considering value for purposes of rate- 
 making, the subject may be approached from two distinct and, 
 in some respects, diametrically opposed directions, one from a 
 knowledge and intent to follow precisely the principles and pre- 
 cepts laid down in the law, based on court decisions, the other 
 from an independent standpoint, regardless of court rulings but 
 with a view to arriving at a fair and equitable value based on a 
 knowledge of the practicable conditions under which construc- 
 tion and operation of public utilities may be carried out, an appre- 
 ciation of the laws of political economy, a knowledge of finance 
 and experience in valuation work. It is recognized by the legal 
 profession that a decision may be technically correct but will work 
 injustice. The courts versed in law rather than engineering have.
 
 FAIR VALUE FOR RATE-MAKING (51 
 
 at times, possibly from lack of proper evidence, rendered decisions 
 that make the law contrary to what it is possible and practicable 
 to carry out in practice. On the other hand, determinations of 
 value that are made without proper consideration of precetlencc; 
 and regard for previous decisions of the courts render the con- 
 clusions liable to be set aside in case appeal is made to the hiw. 
 Therefore, the usual course pursued by those endeavorinji; to make; 
 physical facts and human possibilities conform to legal re(iuire- 
 ments is, with the use of knowledge obtained through tlie con- 
 struction and operation of utility property, and having in mind 
 legal precedence, to determine value upon principles of etpiity 
 and justice, without violating the rules of law. 
 
 The general rule accepted by the investing public is that the 
 present fair value of property is determined from a considcMation 
 of what it is fairly earning and what it may be fairly expected 
 and allowed to earn in the future. This rule, by and far, applies 
 to property regardless of whether it is owned by an individual, 
 an industrial corporation, or a public utility. But, of course, 
 tariffs charged for public utility service cannot be based on a value 
 determined by capitalizing net earnings. Since the tariffs them- 
 selves determine the earnings, equity, common sense, and usually 
 the courts indicate that the tariffs fixed must permit the utility 
 property to earn a fair return upon its to-day's value, not upon 
 what it may have cost originally or be prospectively worth in 
 the future. Moreover, the tariffs, that is, the earnings, must be 
 such as will maintain the fair value of the property, without tend- 
 ing to increase or depress said value, on the basis of capitalizing 
 net earnings. In order to determine and fix the proper tariffs 
 and earnings, the value of the property itself must first be 
 established. 
 
 Investment not Value. — The theory that investment or original 
 cost is value, is based upon the thought that the investor in a 
 public utility should have his investment protected by the 
 pubhc, and receive a fair return thereon from the public, re- 
 gardless of whether the value of his investment increases or 
 decreases. The argument is that if from the beginning there 
 is earned upon the money actually expended by the owner of a 
 property what is now considered a fair return, rates fixed upon 
 the cost basis are equitable, allowance being made for expendi- 
 tures covering deficiencies usually occurring in the early days 
 of a corporation's existence by recognizing such deficits as a part
 
 62 VALUE FOR KATE-MAKING 
 
 of the invest mciit or compensating for them in fixing the rate of 
 return. This theory holds that the owners of property devoted 
 to the pubUc use, by reason of the special privileges and obliga- 
 tions, are entitled to only a reasonable return upon the cash ex- 
 pended, that is, upon the "cost," and should not be allowed to 
 share either in any increment in land or other property values, 
 or in profits larger than a "fair return," although perhaps the 
 higher figures are the result of unusual foresight, business abil- 
 ity, or exceptional opportunity. The "original cost" theory is 
 usually held to be applicable to those utilities which have pros- 
 pered, or the property of which has largely increased in value so 
 that the owners have had more than a so-called "fair return" — 
 usually held to be from 6 to 8 per cent. — upon their investment. 
 Risk to investment at the time of the original expenditure by 
 reason of surrounding local conditions, uncertainty as to success- 
 ful coordination of the physical property, development and im- 
 provements in the art, losses arising from competition, political 
 agitation, unusual accidents, errors of managements, strikes, the 
 time, energy, ability and initiative of the promoters, not usually 
 paid for in money but in stock, are most difficult to understand, 
 appreciate and evaluate years afterward when an enterprise has 
 proven a success, and hence are almost always minimized and 
 under-valued. Consequently the "original cost" theory does 
 not appeal to the owners of successful utilities and has never 
 proposed to be applied, even by its most ardent advocates, in 
 fixing the rates to be paid a non-paying or abandoned proposi- 
 tion. The most liberal use of the theory has been to recognize 
 certain deficits for an arbitrarily limited period only, imme- 
 diately after a corporation starts business, which limited def- 
 icits are taken as the going value of the property; but this is 
 in no sense a practical application throughout its corporate 
 existence of the "cost" theory to an unsuccessful, unprofitable 
 utility which may be serving the public just as faithfully as 
 another more profitable corporation. 
 
 The attempt to apply the "original cost" theory under present- 
 day regulation assumes that the corporation which has been in 
 operation for years, although fixing its tariffs with the tacit and 
 ofttimes expressed approval of State or municipal authorities 
 and supplying generally the requirements of the public, has been 
 making undue and unfairly large profits. Such assumption as 
 to profits is frequently entirely unwarranted and must be recog-
 
 FAIR VALUE FOR RATE-MAKING 63 
 
 nized as an attempt to take from the present owners of a utility 
 a part of its present value. Previous owners may have earned 
 what are now considered too great profits, but as the public regu- 
 lating bodies have not heretofore felt called upon to reduce these 
 profits, although always having the power to do so, on what fair 
 grounds can those former profits now fairly ])e readjusted to 
 present-day standards, or a part of the earlier large earning, that 
 may have been reinvested in the plant, claimed as the property 
 of the pubHc? Evidently the earlier profits were not considered 
 exorbitant in those days by those best able to judge. Utility 
 investments are now often made upon the understanding and 
 agreement that the owners are to be allowed only a fair maxi- 
 mum return, regardless of the financial failure or success of the 
 enterprise. Capital can be interested if the rate paid is high 
 enough, but until recently there has been no understanding or 
 notification that such return would be from 6 to 8 per cent, as 
 a maximum for the successful corporations, with the unsuccessful 
 ones standing their own losses. 
 
 While the courts recognize hona fide investment as one of the 
 important elements to be given due weight in ascertaining values, 
 they are practically in unanimous agreement that the only final 
 basis upon which fair returns must be allowed is fair present value. 
 Nevertheless, some individuals and public service commissions 
 still maintain that cost, namely, the original, cost or cash, invest- 
 ment in the utility property is the only proper basis upon which 
 to determine rates and allow returns. The attempt to base 
 rates merely upon the original cost of investment results not only 
 in unfairness to the present owners, but under many conditions 
 will lead to absurd results, because value cannot be fixed without 
 some regard to net earnings. The cost of a plant in the middle 
 of the Sahara Desert, without ability to earn, would not fix its 
 value. A recent appraisal disclosed the fact that an old type of 
 dynamo, inefficient and out of date, was worth more by reason 
 of the excessive amount of copper it contained, than the cost 
 new of a modern machine capable of delivering the same out- 
 put efficiently. Would the adherents of the investment theory 
 argue that the public should pay a return, in addition to the 
 higher operating costs for energy developed by the obsolete 
 dynamo? 
 
 The investment or cost principle is eminently fair and beyond 
 criticism, provided the investor originally places his money upon
 
 64 VALUE FOR RATE-MAKING 
 
 that understanding, but it is unfair and improper to require an 
 investor to accept such terms when he has put his money into 
 an enterprise upon the understanding that he is taking the risk 
 of loss or gain in his principal, with the concomitant gains or 
 losses in earnings. 
 
 "Again upon the same point it should be said that those who engage 
 in a public service cannot be put upon quite the same level as those who 
 make mere investments. They are not like the depositors in a savings 
 bank, whose right to draw out is limited to precisely what they have put 
 in with its earnings. They are, on the contrary, engaged in a business, 
 with the ordinary incidents of a business, with some of the hazards 
 and some of the hopes of a business. To be successful they must be 
 wise and prudent, thrifty and energetic. These virtues, if they have 
 them, they impress upon the property, making it more valuable than it 
 otherwise would have been. Is it to be said, that they can have no 
 return for skill and good management? We do not think so."^ 
 
 Public regulation is applying the investment theory to capital 
 being added to corporations already under public control or to 
 those enterprises which are being newly inaugurated without 
 much criticism or charges of unfairness, because investment and 
 present values are kept practically equal. 
 
 As a matter of fact, the repeated rulings of the various courts, 
 including the Supreme Court of the United States, show quite 
 clearly that original investment value is not the value of existing 
 property. Without attempting to quote a long list of judicial 
 decisions in this matter, some of which have been quoted in 
 preceding pages, it may be pertinent to refer to the explicit 
 language of the Supreme Court in a few instances, as for example 
 in the case of the San Diego Water Company, where the Court 
 said: 
 
 "The contention of the appellant in the present case is that in as- 
 certaining what are just rates, the Court should take into considera- 
 tion the cost of its plant. The basis of calculation suggested by the 
 appellant is, however, defective in not requiring the real value of the 
 property and the fair value in themselves of the services rendered to 
 be taken into consideration. What the company is entitled to demand, 
 in order that it may have just compensation, is a fair return upon the 
 reasonable value of the property at the time it is being used for the 
 public. "■- 
 
 ' Brunswick & Topshaw Water District vs. Maine Water Co., 99 Maine 379. 
 "San DicKo Land & Town Co. National City, 174 U. S. 757.
 
 FAIR VALUE FOR RATE-MAKING 65 
 
 In the case of the ConsoHdated Gas Company tlie Court said: 
 
 "There must be a fair return upon the reasonable vahie of the property 
 at the time it is being used for tlio pubHc."' 
 
 In the more recent Minnesota rate cases the Supreme Court 
 said: 
 
 "It is clear that in ascertaining the present value, we are not limited 
 to the consideration of the actual investment. The property is held in 
 private ownership and it is that property, and not the original cost of 
 it, of which the owner may not be deprived without due process of hiw."- 
 
 In another railway case the Supreme Court said: 
 
 "Will it be said that the taxation must be based simply on the cost, 
 when never was it held that the cost of the thing was the test of its 
 value?"' 
 
 "We hold, however, that the basis of all calculations as to the rea- 
 sonableness of rates to be charged by a corporation maintaining a 
 highway under legislative sanction must be the fair value of the property 
 being used by it for the convenience of the public."'' 
 
 Aside from the convincing language of the courts, it is very 
 frequently found in practice impossible to ascertain from cor- 
 poration records the investment value of the property. This 
 condition results not always from intention to conceal such 
 facts, but by reason of the earlier methods of keeping corporation 
 records, and the fact that utilities, at least those of large size, 
 are usually the result of sale, consolidation and amalgamation 
 so that the records of the subsidiary companies would not pass 
 to the existing corporation, and have been lost or destroyed in 
 the ordinary course of business. Those advocates of the uni- 
 versal application of the investment theory apparently over- 
 look this very important actual condition of affairs, namely, 
 the inability to get at or produce records. 
 
 Under existing public regulation methods, a most satisfactory 
 basis of valuation for a recently created property is th(^ actual 
 cost, excluding any unreasonable, extravagant or untair ex- 
 penditures. While on the one hand the public should not be re- 
 quired to pay a return upon injudicious or extravagant expendi- 
 
 1 Wilcox et al vs. Consolidated Gas Co., 212 U. S. 19. 
 
 2 Minnesota Rate Cases 230 U. S. 352. 
 
 ^ C. C. C. & St. L. Rwy. Co. vs. Backus, 154 U. S. 446. 
 * Smyth vs. Ames, 169 U. S. 546. 
 5
 
 66 VALUE FOR RATE-MAKING 
 
 tures, on the other hand, all investments that have been honestly 
 made in preparing to render the service, must be included in the 
 value of the property. T ^se costs relate not only to the 
 structural property, but include all those expenditures for in- 
 tangible items, or overhead charges, such as administration and 
 organization expenses, cost of promotion, incidentals, en- 
 gineering, interest and taxes during construction, etc., as well 
 as going value, or the cost of developing the business and secur- 
 ing the revenue. 
 
 It would, of course, be unfair to apply the investment theory 
 to certain utilities and apply another theory, which would rela- 
 tively increase values, to the other utilities. For example, in 
 the Interstate Commerce railway valuations now being made, 
 there are available records of all more recent construction, so 
 that investment cost can be ascertained, but with regard to 
 much of the property no records are obtainable, so that some 
 other method must be used in fixing values. It would evidently 
 be inconsistent and unfair to apply different methods to the 
 same property, or one method to a railroad which had records 
 available and another method to a railroad which had no records. 
 Therefore, some more uniformly applicable method than the in- 
 vestment theory must be used in determining values. 
 
 Basis of Value. — The highest courts have, beyond contro- 
 versy, settled the fact that the owner of property devoted to, 
 or reasonably necessary for, the service of the public is at least 
 entitled to a fair return upon the fair value of such property. 
 This conclusion of the courts is the extreme minimum allowable 
 under the well-known clause of the Fourteenth Amendment to 
 the Federal Constitution prohi})iting confiscation of private 
 property. Such conclusion docs not necessarily preclude the 
 principle that aside and in addition to return on property the 
 owner may be entitled to remuneration for efhciencj^ or the 
 high class of service rendered, so that equitable rate-regulation 
 should consider both property and service. The power to regu- 
 late rates is primarily based on the principle that justice is to 
 be done both the owner of the property and the customers 
 served thereby, but before fixing the tariffs for particular service 
 rendered the consumers, there must be determined proper gross 
 revenues which shall be sufficient to at least afford a fair return 
 on the value of the property used, in addition to a reward for 
 especial services — if any — and operating expenses, including de-
 
 FAIR VALUE FOR RATE-MAKING (;; 
 
 prociatioii. (Consequently, even admitting minor diiTerenees in 
 opinion as to the proper basis for rate-making, practically all 
 agree that the value of the physical property used in the service 
 is one of the most essential facts to be known before rate-making 
 can proceed. Even though the character of service is excluded 
 from consideration and it is held that rates are to be determined 
 upon the cost of the service, there are instances where, even 
 under such theory, rates cannot be made sufficiently high to 
 furnish an adequate return upon the value of the property, 
 because of the relatively large investment, high operating 
 expense or by reason of competition or other unfavorable cir- 
 cumstances. Such cases, however, may be considered rather 
 exceptional and abnormal, so that the methods of determining 
 value and fixing rates, generally applicable, will not apply. 
 
 While the broad principles to be used in determining fair value 
 are recognized, the detailed method of determining such value is 
 more or less vague and the subject of much controversy. And, 
 yet, uniformity of methods of valuation are really essential, if 
 satisfactory relations between the utilities and the public are 
 to be obtained and fairness and justice rendered to both. 
 
 As yet, public authorities, particularly the Supreme Court, 
 have failed to indicate definite and complete rules to be applied 
 in determining the fair value of utility property. Nevertheless, 
 the higher courts have indicated the general principles which 
 may be used as guides in determining the fair value to be es- 
 tablished, in any particular case. They are: 
 
 First. — The original cost of the property of which the fair value 
 is being determined. 
 
 Second. — The cost of reproducing new at the present time, 
 with current prices, the existing property. 
 
 Third. — An estimate of the loss in value, the depreciation, if 
 any, that has resulted to the property in rendering service. 
 
 Fourth. — The amount and market value of the stock and 
 bonds outstanding, including both the original and subsequent 
 issues. 
 
 Fijth. — The gross revenue and operating expenses. 
 
 Sixth. — The worth of the service rendered. 
 
 While all of the above elements mentioned by the courts are 
 to be considered in determining value in any given case, the 
 relative weight and importance of any given element must be 
 determined by the authority fixing value. These views are in
 
 68 VALUE FOR RATE-MAKING 
 
 accordance with court rulings, as clearly indicated in the National 
 Water-works Company case, where the Court said: 
 
 "We are not satisfied that either method, by itself, will show that 
 which, under all circumstances, can be adjudged 'the fair and equitable 
 value.' Capitalization of the earnings will not, because that implies a 
 continuance of earnings, and a continuance of earnings rests upon a 
 franchise to operate the water-works. The original cost of the con- 
 struction cannot control, for 'original cost' and 'present value' are not 
 equivalent terms. Nor would the mere cost of reproducing the water- 
 works plant be a fair test, because that does not take into account the 
 value which flows from the established connections between the pipes 
 and the buildings of the city. It is obvious that the mere cost of pur- 
 chasing the land, constructing the buildings, putting in the machinery, 
 and laying the pipes in the streets — in other words, the cost of repro- 
 duction — does not give the value of the property as it is to-day. A 
 completed system of water-works, such as the company has, without a 
 single connection between the pipes in the streets and the buildings of 
 the city, would be a property of much less value than that system con- 
 nected, as it is, with so many buildings, and earning, in consequence 
 thereof, the money which it does earn. 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. The fact 
 that the company does not own the connections between the pipes in 
 the streets and the buildings — such connection being the property of 
 the individual property owners — does not mitigate against the proposi- 
 tion stated, for who would care to buy, or at least give a large price for, 
 a water-works system without a single connection between the pipes 
 in the streets and the buildings adjacent? Such a sj'^stem would be a 
 dead structure, rather than a living and going business. The additional 
 value created by the fact of many connections with buildings, with 
 actual supply and actual earnings, is not represented by the mere cost 
 of making such connections. Such connections arc not compulsory, 
 but depend upon the will of the property owners, and are secured onlj' 
 by efforts on the part of the owners of the water-works, and induce- 
 ments held out therefor. The city, by this purchase, steps into 
 possession of a water-works plant — not merely a completed system 
 for Ijringing water to the city, and distributing it through pipes placed 
 in the streets, but a system already earning a large income by virtue 
 of having secured connections between the pipes in the streets and a 
 multitude of private buildings. It steps into possession of a property 
 wliich not only has the ability to earn, but is in fact earning. It should
 
 FAIR VALVE FOR RATE-MAKIXC m 
 
 pay, therefore, not merely the vakie of a system wliicli iiiij^lit he ih.'kIc 
 to earn, but that of a system which does earn."^ 
 
 Some discussion of the merits and weight of the several 
 elements to be considered, in accordance with the instructions of 
 the courts, has been had in preceding pages, others will be dis- 
 cussed more fully hereafter, but it should be here recognized Ihat 
 value is the result of judgment and cannot be mathematically 
 deduced from a consideration of an}^ one or all of the six elements 
 specified above. The six elements of cost may be considered as 
 pedestals supporting the platform on which rests the determined 
 value. Which one of the pedestals, or whether more than one, 
 shall carry the principal part of the weight in arriving at the 
 value fixed, may be determined in each case, but as a rule the 
 second and third elements named are primarily, and the fifth 
 and sixth elements secondarily of greatest importance in every 
 valuation. The reasons why original cost is not of primary 
 importance in fixing the value of utility property that was created 
 before the present era of public service regulation, have already 
 been discussed in preceding pages. The value of outstanding 
 stocks and bonds, or other securities, cannot usually be urged or 
 accepted as the proper basis of fixing present value for the 
 reason that some utilities have not issued securities equal in 
 value to their property, while others have issued too large 
 amounts and have outstanding "watered" securities. 
 
 The Honorable F. W. Stevens, formerly chairman of the 
 Public Service Commission of New York, Second District, very 
 clearly indicates the use to be made of the word "value" in 
 connection with the appraisals of the property made for rate 
 determinations : 
 
 "A thing may be valuable without any reference to money, but 
 whenever we speak of value in the economic sense, we express it in 
 terms of money, and value is nothing but a ratio, an expression of a 
 relation between money and the article valued. Now, what determines 
 the ratio; what determines the relation? It is nothing more nor less 
 than a mental condition. It is a state of mind with reference to the 
 article, and not an attribute or quality of the article itself. If you 
 happen to own a fine residence, upon a fine street, with some vacant 
 lots near you which you consider to be worth any given sum of money, 
 we will say, for example, $10,000, and suddenly upon one side of 
 you there is put up an Italian boarding house, and upon the other 
 
 ■ National Water-worka Co. vs. Kansas City, 02 Fed. 865.
 
 70 VALUE FOR RATE-MAKING 
 
 side a drinking saloon, something has happened to the value of your 
 property. What is it? The property is there just the same; there 
 is no change in the property itself. The house is just as good, the lot 
 is just as good. But what you could sell for $10,000 before you cannot 
 now sell for $5,000, we will assume. The surrounding circumstances 
 are such as to change the estimation of people who would want to buy 
 such a piece of property regarding it. Before they would rather have 
 the property than $10,000. Now they would rather have the $10,000 
 than the property, and will part with only $5,000, showing that the 
 value is nothing but a relation between money and the article valued, 
 and that relation depends upon the state of men's minds. That may 
 seem rather metaphysical, and rather theoretical, but it is the funda- 
 mental principle which you must grasp if you are going to solve this 
 question of value."' 
 
 Present Value. — In determining the value of utility property, 
 not only must the quality of fairness, as between the owners and 
 the public, be considered, but the fair value at the date of the 
 inquiry, that is, present fair value must be established. ''Pres- 
 ent" value means the "here and now" value of the property 
 used, useful, or reasonably required for the service being rendered. 
 Fair present value is the result of a judgment formed from the 
 consideration of the "facts, figures and law" involved in each 
 particular case. 
 
 "What the company is entitled to demand, in order that it may 
 have just compensation, is a fair return upon the reasonable value of 
 the property at the time it is being used for the public."^ 
 
 "In estimating the value of the property, we must take, not what was 
 its value in the past, nor what it cost, nor what it would cost to duplicate 
 it, nor its probable future value, but the estimate must be based on its 
 present value. "^ 
 
 "Under the authorities, in fixing the rate to be charged for the 
 'public service' by private corporations, two elements of calculation 
 are of fundamental importance: What is the true present value of the 
 property embarked in the enterprise? and what, in view of the risks of 
 business, is a fair, annual percentage of return thereon?"'* 
 
 "It is impossible to observe this continued use of the present tense 
 in these decisions of the highest court, without feeling that the actual 
 
 ' Address delivered before tlie American Elcctrio Railway Association af Atlantic City, 
 Oct. 14, 1914. 
 
 * San Diego Land & Town Company vs. National City, 174 V. S. 57."). 
 ' .Matthcw.s vs. Board of Corp. Com'rs, 106 Fed. 7, 9. 
 
 * Consolidated Gas Co. vs. Mayer, 146 Fed. 1.50, 150.
 
 FAIR VALVE FOR RATK-MAKIXC 71 
 
 or reproductive value at the time of the inquiry is the fust and most 
 important figure to be ascertained."^ 
 
 This doctrine, as thus announced, was sustained in tlic famous 
 New York City gas case by the United States Supreme Court in 
 the following plain statement: 
 
 "There must be a fair return upon the reasonable value of the property 
 at the time it is being used for the public."^ 
 
 In Cotting vs. Kansas City Stock Yards Co. there is a review 
 of all the prior cases decided by that court involving the fixing 
 of rates by legislative enactment and reaffirmation of its previous 
 position. 
 
 "It (the Supreme Court) has declared that the present value of the 
 property is the basis by which the test of reasonableness is to be deter- 
 mined, although the actual cost is to be considered, and that the value 
 of the services rendered to each individual is also to be considered."* 
 
 In Cumberland Tel. & Tel. Co. vs. City of Louisville, 187 
 Fed. 637, on page 642, the rule is stated as follows: 
 
 "It would seem clear from the decisions that the most material 
 question in such cases is that of the reasonable value of the property 
 'at the time it is being used for the public' — that is to say, the time at 
 which the question arises — it being upon the reasonable valuation at 
 that time that the company is entitled to earn a fair return. * * * 
 The value of a plant may depend upon good fortune, upon good manage- 
 ment, or upon fortuitous circumstances, but in every event the reason- 
 able value of the property 'at the time it is used for the public' is the 
 value we are to ascertain for the purposes of this controversy." 
 
 "The property is held in private ownership, and it is that property, 
 and not the original cost of it, of which the owners may not be deprived, 
 without due process of law."^ 
 
 In Louisville & N. R. Co. vs. Railroad Commission, 196 Fed. 
 800, an objection was made, because, in fixing the value of the 
 plant, present prices were used instead of those prevailing at the 
 time the plant was constructed. In answer to this objection, 
 the Court, at page 821, says: 
 
 "One of the objections of the respondents is that the estimates were 
 based on the prices of 1907 when they were made, and that they were 
 
 » Consolidated Gas Co. vs. Wilcox, 157 Fed. 849. 
 ^ Wilcox vs. Consolidated Gas Co.. 212 U. S. 19, 41. 
 ^ Cotting vs. Kansas City Stock Yards, etc., 183 U. S. 91. 
 * Simpson vs. Shepard, 230 U. S. 352.
 
 72 VALUE FOR RATE-MAKING 
 
 then unusually high. This is disposed of by the point that present 
 values are required to be taken and used in determining present and 
 prospective rates." 
 
 The recent case of Des Moines Water Co. vs. City of Des 
 Moines, 192 Fed. 193, is a thoroughly considered case, both by 
 the master and by the Court which affirmed the master's de- 
 cision. In that case, at page 196, is the following statement: 
 
 "The question is not what it (the plant) cost, although such evidence 
 is admissible as having a bearing. The question is not what the plant 
 some day may be worth, although evidence with reference thereto may 
 be considered as having a bearing. The question is : What is the value 
 of the plant to-day? There must be a reasonable rate of interest or 
 dividends allowed on the value of the plant." 
 
 Eminent authorities in the line of engineering, law and eco- 
 nomics differ in the valuation of utility properties, as to whether 
 "present cost," as enunciated by the Court, shall be taken to 
 mean the cost new or whether that cost must be reduced by an 
 estimated amount of accruing depreciation not yet fully accrued. 
 The lower courts and commissions have given conflicting opinions 
 on this point and the superior court has rendered somewhat 
 indefinite and contradictory decisions on this particular ques- 
 tion. It is difficult to understand why the term used by the 
 Supreme Court "present cost" should be taken by anyone to 
 mean present cost less depreciation. It should be noted that 
 the Supreme Court avoids saying that accruing depreciated cost 
 is the present value, such meaning simply being a contortion 
 of the statement of the decision in the Smyth vs. Ames case. 
 
 In a rate case, the question to be determined is the present — 
 meaning now — value of the property, being used for the service 
 of the public. This value is to be fixed by the exercise of judg- 
 ment, from a consideration of the several evidences of cost, 
 namely, the original investment, the reproduction cost new, and 
 both of these reduced by the cost of discarded and no longer 
 useful apparatus to get present cost, as well as a consideration of 
 the market value of stocks and bonds, together with expenditures 
 for improvements and maintenance. 
 
 Where records of investment are not available reproduction 
 cost becomes all-important in determining the value of the property 
 serving the public, which present value exists regardless of the 
 credit of the corporation, the state of its assets, or whether the
 
 FAIR VALUE FOR RATK-MAKIXG 7:i 
 
 corporation obtained the property as the resuh of (he side of 
 bonds, stocks, notes, by gift or from accuniidations of suri)lus. 
 
 Rates cannot be based upon earnings i)revious to (lie inaug- 
 uration of public regulation of such earnings. If attempt wen; 
 made to consider past earnings in determining value of property, 
 should the consideration include earnings for one, two, five or ten 
 years, and if so, why not for a longer period, say from the origin 
 of the company. If the earnings should be found to be nion; 
 than a fair return upon the value of the property, in addition to 
 a proper sum to cover all depreciation, why should not such ex- 
 cess be also deducted from cost new, in determining present value, 
 the same as it is proposed to deduct the amount of a theoretically 
 computed reserve fund. Such procedure, while logical, would 
 not be reasonable or justified by the courts, for no corporation 
 can retroactively be required to account for its surplus or its 
 deficiency previous to the initiation of public regulation. 
 
 "Should the Government to-day take note of that surplus for the 
 purpose either of so reducing the rates of the company that no earnings 
 can be made upon this much of the property, or with a view in some 
 sense to turn that surplus back again into the hand of the public? 
 
 "During all this period the excess has gone into the property, which has 
 gradually become more valuable, and this increased value has reflected 
 itself in the market price of the securities of that company. It is 
 impossible to restore what has been improperly taken in the way of 
 excessive rates to those persons from whom it has been received. The 
 Government, under those circumstances, cannot lay hold on this surplus 
 as a fund held in trust for the public. 
 
 "This case strongly illustrates the fact that if any Government tribunal 
 is to do justice between the railway and the public, if it is to feel any 
 confidence in the correctness of its conclusions, its supervisions must 
 be continuous and not spasmodic. There must be some point of de- 
 parture and from that point the knowledge of the Government must be 
 accurate and complete. After earnings have once been 'capitalized' 
 and benefits have been 'conferred,' when the various independent 
 organizations have been perfected ^ it is impossible to either know or to 
 undo."i 
 
 The Supreme Court, of the State of Massachusetts, has 
 definitely held— contrary to the order of the Gas and Electric 
 Light Commissioners — that a utility is entitled to capitalize 
 proper expenditures for plant additions, regardless of and aside 
 
 ' Commissioner Prouty of the Interstate Commerce Commission in Spokane vs. Northern 
 Pacific Railway Company, 15 I. C. C. R. 376, 4ir>, Feb. <), 1909.
 
 74 VALUE FOR RATE-MAKING 
 
 from what profits it may have earned. The Fall River Gas 
 Works Company, after pa3'ing dividends at the rate of 10 or 
 12 per cent, per annum, had remaining as profits an amount 
 exceeding bona fide obligations incurred in making additions to 
 plant and property of S200,000, for which notes had been issued, 
 plus $40,000 for proposed equipment expenditures. The cor- 
 poration, instead of applying its profits to the discharge of these 
 obligations, distributed its profits among its stockholders in the 
 form of two extra dividends of 15 and 20 per cent, respectively. 
 Afterward the company sought the Commission's approval of 
 the issuance of 1,150 shares of additional capital stock at the 
 price of S225 per share, the proceeds to be used to meet the 
 $240,000 of notes and proposed expenditures. The Commis- 
 sioners refused to authorize the issuance of stock on the grounds 
 that the profits of the company were sufficient to take up the 
 notes without increasing the capital account; the Commission 
 did not question the propriety or reasonable necessity of the 
 plant additions, or that the amount expended represented their 
 cost and real value. The Court, in overruling the Commission's 
 refusal to authorize the issuance of additional capital, says: 
 
 "When the corporation has performed all its duties, and by its for- 
 tunate situation, good management, or any lawful conduct has remain- 
 ing a surplus of earnings, it has the right to distribute this surplus among 
 its stockholders in dividends. As between the public and the corpora- 
 tion the earnings belong to the corporation. In performing its full 
 duty to the public and others it has done what it was chartered to do, 
 and is entitled to the profits of the business for which it was chartered. 
 If there be any reserved power in the charter whereby the profits can 
 be reduced or the charter revoked, of course, that power may be invoked 
 if it appear that the charter is too favorable to the corporation. And 
 in the case of a gas company the profits may be reduced by an order 
 lowering the price of gas, if such order seems just and reasonable. 
 (R.L., c. 121, §34.) The relations between a public-service cor- 
 poration and the public to serve whom it is chartered are not that of a 
 partnership, but rather that of independent contracting parties. The 
 public may demand proper service, and with that demand the corpora- 
 tion must comply. The company may demand fair compensation for 
 this service, and with that demand the public should comply. The 
 corporation can have no share in the benefit to the public, nor can the 
 public have any share in the net profits available for dividends. 
 
 "Upon the question whether there shall be an issue of additional 
 stock to meet liabilities incurred in increasing the efficiency or value of
 
 FAIR VALUE FOR RATE-MAKING 75 
 
 the plant, the amount of undivided profits on hand at the time (ho 
 liabiUties were incurred or the expenditures made which thercaffcr- 
 ward and before the apphcation to the Board have been hiwfully 
 distributed as dividends is (Mitirely ininuiterial. We see nothing to take 
 this case out of the general rule. 
 
 "Nor is this proposed increase a violation of the statutory provision 
 against the issue of a stock dividend. It certainly is not in form such 
 an issue. Nor is it in substance. The sum raised goes to increase 
 the value of the plant for the purposes of the business for wliich the 
 petitioner was incorporated; S,nd that is none the less true, even if these 
 expenses could have been paid by the funds since lawfully distributed 
 as dividends. 
 
 "It follows that in the decision to dismiss the petition upon the grounds 
 stated in the record there was error in law.""^ 
 
 Property kept in first-class operating condition is entitled to 
 a fair return on the full value of that property, without deduction 
 for theoretical, accruing depreciation, which does not yet call 
 for any renewal of parts. The fact that the property is rendering 
 100 per cent, service must be determined by inspection and not 
 from a consideration of life tables. 
 
 The consumer is only interested in the service rendered and 
 is not concerned as to just when certain parts of the plant must 
 be replaced from one cause or another. The present value of 
 the plant, as far as the consumer goes, is its present value to 
 render the requisite service, without regard to the amount of 
 cash or reserve funds on hand or the expectation of life of the 
 several parts of the physical property, as computed by various 
 methods and differing experts. 
 
 It is not claimed that the cost new of all the property that may 
 be owned and inventoried is the proper value to be taken as the 
 basis for determining rates. This is illustrated, for example, 
 by the fact that claim is made only for scrap or salvage value of 
 apparatus, held simply awaiting a favorable opportunity of sale, 
 no longer used in service to the public, having been displaced by 
 new apparatus. It is admitted if the value of superseded, 
 obsolete, inadequate or not actually used property is included in 
 the inventory at cost new that such value must be reduced by 
 the full amount of depreciation necessary to represent such actual 
 deterioration. Depreciation of the class here referred to can be 
 properly determined only by inspection of the physical property, 
 
 > Fall River Gas Works Co. vs. Board of Gas and Electric Light Commissioners, 214 
 Mass. 529.
 
 76 VALUE FOR RATE-MAKING 
 
 and in most utilities a deduction on account of such depreciation 
 will amount to but a few per cent, of the cost new. With de- 
 duction having been made for such deterioration as is shown to 
 exist as the result of inspection, the full remainder of the cost 
 new represents present value. In this manner only is the cost 
 new of all property inventoried and fairly appraised, to be re- 
 duced for the purpose of fixing fair returns and determining 
 rates. 
 
 Court Decisions. — It is conceded that the decisions of some 
 authorities hold that, in determining the value of property 
 upon which to fix rates of returns, deduction from cost new, on 
 the basis of a theoretical computation should be taken into 
 account, but this is not the ruling of the United States Supreme 
 Court. 
 
 In considering any decision of the Supreme Court, it must 
 be borne in mind that the Court is passing on the particular 
 case in question and any conclusions reached are based upon 
 the peculiar circumstances surrounding that particular property. 
 Consequently, too much importance should not be attached to 
 the decision of the Supreme Court in some individual case when 
 attempting to arrive at the fundamental principles which may 
 be applied generally. While it is true that the last word in 
 any particular instance rests with the Supreme Court, and 
 that such Court is given to following precedent, nevertheless, 
 it cannot be presumed that the Court will seek to perpetuate 
 what may be demonstrated to be a wrong, merely to avoid 
 reversing itself. 
 
 No question can be regarded as finally settled until settled 
 equitably. Because, in the Consolidated Gas case, the Supreme 
 Court held that to maintain a pressure of 2}-^ in. (0.09 11). per 
 square inch) in all gas pipes in the distributing system in New 
 York City, "the mains and other pipes would have to be strength- 
 ened" is so contrary to fact and what even the commonest 
 laborer employed about gas works knows to be the fact, that 
 eventually the Supreme Court nuist reverse itself on this con- 
 clusion, rather than that the laws of nature are to be revised. 
 
 Minnesota Rate Cases. — In the same way, the statement of 
 Judge Hughes in the Minnesota rate cases to the effect that 
 
 "We also think it was an error to add to the amount taken as the 
 present value of the lands, the further sums calculated on that value.
 
 FA IJi VALUE FOR RA TE-M A K I XC 77 
 
 which are embraced in the items of 'engineerinfr/'superinteiulence,' 
 'legal expenses,' 'contingencies' and 'interest during constructi<jn,' " 
 
 and the further statement in the same decision, 
 
 "It is impossible to assume, in making a judicial finding of wliat it 
 would cost to acquire the property that the company would be com- 
 pelled to pay more than its fair market value. It is equipped with the 
 governmental power of eminent domain," 
 
 are contrary to common knowledge and experience. Any ap- 
 parent conclusion that a railroad could purchase real estate by 
 reason of its right of eminent domain at the value of adjoining 
 land is so contrary to common knowledge and experience in 
 railway construction that the estabhshment of such principles 
 could not be accepted even if attempted by the Supreme Court. 
 If, in the Minnesota rate cases, evidence was improperly pre- 
 sented as to the necessity for allowing engineering and other 
 incidental expenses, or the fact that real estate cannot be pur- 
 chased at the value of adjoining land, was not established in the 
 record, that may have been sufficient grounds for the refusal 
 of the Supreme Court to accept the values claimed by the rail- 
 roads, but any deficiency in the evidence necessary to prove 
 the proper basis of value upon which to fix rates cannot be as- 
 sumed as conclusive and a safe premise on which to base a 
 succeeding case in which it may be presumed the Court will have 
 full and proper information on these subjects. 
 
 It is more than likely that what the Court in the Minnesota 
 rate cases was pointing out as error in the values claimed for 
 rights-of-way was that the valuation had been made upon the 
 wrong theory, which was an estimate in excess of the market value 
 of contiguous and similar property increased by the multiplier, 
 three. That upon such erroneous basis or amount, further sums 
 could not be fairly added for "engineering, superintendence, 
 legal expenses, contingencies and interest during construction." 
 There is no warrant for supposing that the Court would have 
 condemned a method which started with the fair market value 
 of contiguous property and increased that amount by the projM-r 
 multiplier. It would be absurd to assume that the Court m- 
 tended to imply that the railroad, at present, was only entitled 
 to such value for its right-of-way as that right-of-way had cost 
 when the railroad was built perhaps half a century ago, or what 
 it would cost if the territory had never been served by a railroad.
 
 78 VALUE FOR RATE-MAKING 
 
 Consolidated Gas Case. — The particular question with ref- 
 erence to whether the amount of depreciation of physical prop- 
 erty was to be determined from actual inspection or from cal- 
 culations based on estimated life tables was squarely involved 
 in the Consolidated Gas case and definitely passed upon by the 
 master appointed to take the testimony in that celebrated case. 
 The total valuation of that property was some $56,000,000, It 
 was shown that an expenditure of $604,988 for "repairs" (slightly 
 over 1 per cent.) would make the plant as good as new, and this 
 is the only sum that was deducted from the reproduction cost 
 new, notwithstanding, it was most vigorously contended by the 
 plaintiff in that case that a further deduction of millions of 
 dollars should be made for theoretical or "accrued" deprecia- 
 tion. The master says, regarding the testimony of the expert 
 for the plaintiff, Mr, Marks, and for the defendant, Mr. Mayer, 
 that 
 
 "Mr. Marks did not particularly regard the extent of depreciation 
 actually existing, but assumed a theoretical deterioration of the supposed 
 life of the plant. He testified: 
 
 'Depreciation results from several causes. The most ordinary one 
 is decay or wear and tear, as observed. There is another factor which 
 is inadequacy, owing to the increase of the business. There is also 
 another cause of depreciation, obsolescence, which is due to the changes 
 in the arts and in the methods and in the general growth of scientific 
 knowledge; if a works built at a certain period is kept in perfect repair, 
 meaning by that, always restored to their original condition, there 
 remains, assuming that, a depreciation due to both obsolescence and to 
 inadequacy.' 
 
 "In this view he made estimates on the theory of the cost of final 
 replacement to cover such inadequacy or obsolescence, ranging from 
 25 per cent, to 60 per cent, and based on a supposed life of 120 years 
 for the plant. The discrepancy between his valuations and those of 
 Mr. Mayer is largely due to their different methods of estimating de- 
 preciation. He said: 
 
 'Mr. Mayer does not differ largely from my own figures of structural 
 cost. You may say for all ordinary purposes they coincide, with the 
 exception of the gas holders and even there they do not differ largely. 
 It is the question of depreciation entirely.' 
 
 "As will hereafter appear, it is proper in the administration of a 
 manufacturing plant to take depreciation of the character above 
 described into account and provide against it by setting aside a reserve 
 fund from current earnings. For the purpose of determining present
 
 FAIli VALUE FOJi RATE-MAKING TO 
 
 value, however, particularly on the basis of cost of reproduction, the 
 method followed by Mr. Marks does not commend itself. It app(!ars 
 from the record, without substantial dispute, that while certain (»f the 
 plants and apparatus may not be in perfect repair, they are as a whole 
 in efficient operating condition, and that a large proportion of their 
 capacity is represented by the latest pattern of water gas apparatus 
 installed within the last few years. * * * 
 
 "The fact thus being that the plants are in good order and operating 
 efficiently, it does not appear reasonable, for the purposes of this case, 
 to charge them with a theoretical deficiency so great, as, if actually 
 existing, would make their successful operation a practical impossi- 
 bihty. An estimate of depreciation like those of Mr. Edgerton and 
 Mr. Mayer, based on a detailed examination of the property as it stands 
 to-day, affords in my opinion a more fair and j^racticable method to be 
 followed in determining its value." ^ 
 
 The master, in this case, in dealing with the allog(>(l necessity 
 for a reserve fund to provide for "final renewals" when the life 
 of the apparatus should expire, says: 
 
 "Of course, the requirement of such 'final renewal' provision affects 
 in no way the present value or efficiency of the plants of the company as 
 operating concerns, except to the extent of the repairs ($604,988 above 
 mentioned), which would be required to make the operating plant as 
 good as new."^ 
 
 From the above, which is probably as full an exposition of 
 the proper basis for estimating depreciation as was ever passed 
 by the Supreme Court, several important points would seem 
 to be made clear: 
 
 (a) Depreciation should be determined by personal inspection 
 rather than by theoretical estimate. 
 
 (b) Property that is in good order and operating efficiently, 
 although not new, need not necessarily be depreciated, at least 
 in rate cases. 
 
 The decision of the Supreme Court in the ConsoUdated Gas 
 case has not been given due consideration in the matter of 
 depreciation as against the same court's decision in the Knoxville 
 Water case, although both decisions were rendered the same 
 day. In the writer's opinion there is no contradiction betwoon 
 these decisions as to the meaning of "fair value" or method of 
 allowing for depreciation if the decisions are fairly interpreted. 
 
 ' Mastor's Report, Consolidated Gas Co. of New York. Filed June 24. 1907, pane i:(7.
 
 80 VALUE FOR RATE-MAKING 
 
 Fair Rate. — The fair return that should be allowed will vary 
 under different circumstances and localities and must be de- 
 termined for the particular case being considered. The fixing 
 of a fair return is an entirely separate and distinct question from 
 determining the fair value of the property used. In fairness, 
 one cannot be made low and offset by making the other high, 
 and vice versa. Consequently, no attempt is made herein to 
 name all the elements to be considered, but rather merely to 
 discuss what may be some of the general principles for arriving 
 at and fixing a fair rate of return, bearing in mind the fact that 
 the rate of return is entirely independent of and distinct from 
 the fair value of the property. 
 
 The now generally accepted view prevails that the utility is 
 not only entitled to have the fair present value of its property 
 recognized, but the return allowed upon the value must also be 
 sufficient to sustain and maintain that value. 
 
 "But as it is firmly established that it is within the scope of judicial 
 power, and a part of judicial duty, to inquire whether rates so established 
 (by Municipal Ordinance) operate to deprive the owner of his property 
 without just compensation, it seems to me that it logically follows that 
 if the Court finds from the evidence produced that they are manifestly 
 unreasonable, it is its duty to adjudge and to annul them, for it is plain 
 that if they are manifestly unreasonable, they cannot be just. In the 
 solution of that problem many considerations center; among them, 
 the amount of money actually invested. But that is by no means, of 
 itself, controlling, even where the property was at the time fairly worth 
 what it cost. If it has since acquired any value, those who invest 
 their money in it, like others who invest their money in any other kind 
 of property, are fully entitled to the benefit of the increased value. If, 
 on the other hand, the property has decreased in value, it is but right 
 that those who invested their money in it, and took the chance of the 
 increase of value, should bear the burden of the decrease. In my judg- 
 ment, it is the actual value of the property at the time the rates are 
 fixed that should form the basis upon which to compute just rates, 
 having at the same time due regard to the rights of the public, and to 
 the cost and maintenance of the plant and its depreciation by reason 
 of wear and tear."^ 
 
 The more usual view of the courts as to the controlling principle 
 to guide in fixing rates has been clearly set out in the Spring 
 Valley Water Works decision as follows: 
 
 1 San Diego Land & Town Co. vs. City of National City, 74 Fed. Rep. S3.
 
 FAIR VALUE FOR RATE-MAKING 81 
 
 "It is not a matter of guess work or any arbitrary fixing of rates with- 
 out reference to the rights of the water company or the public. When 
 the constitution provides for the fixing of rates or compensation, it 
 means reasonable rates and just compensation." ^ 
 
 The above view has not been uniformly held. Although 
 Judge Brewer, in a railroad case, makes the following startling 
 statement, his conclusion is not in accord with the later lulings 
 of the courts as was shown under "Development of Law," pag(! 7: 
 
 "Whether by reducing the compensation to a minimum railroad 
 enterprises shall be discouraged, or, enlarging, encouraged, is a matter 
 for legislation, and not judicial determination. Take a kindred matter. 
 It is within the power of the Legislature to prescribe the rate of interest, 
 and to punish by severe penalties the exaction of larger than the legal 
 rate. What that legal rate shall be is not for the courts, but for the 
 Legislature, to determine. Suppose the Legislature of Iowa should 
 reduce the legal rate of interest to 1 per cent., although such Legislature 
 would prevent capital from coming into the State, would the courts 
 have power to declare the law unconstitutional? In like manner, the 
 rulings of the Supreme Court imply that the Legislature may reduce 
 railroad rates until only a minimum of compensation is secured to the 
 owner. The rule, therefore, to be laid down is this: that where the 
 proposed rates will give some compensation, however small, to the 
 owners of the railroad property, the courts have no power to interfere."^ 
 
 A fair return upon utility property may equitably be taken 
 to mean an amount sufficient to cover ordinary interest and, in 
 addition, some reward or profit based on the local conditions and 
 risks incidental to the requirements of invested capital, under 
 the particular circumstances in question. This fair return is 
 over and above all expenditures for service, the expenses of con- 
 ducting the business and the costs of maintaining the property 
 in first-class operating condition. Of course, operating expenses 
 include expenditures for fuel, oil, water, wages, salaries, taxes, 
 normal wear and tear, and maintenance, as \\iA\ as renewals 
 and replacements, whether necessitated by exhaustion of j)hysical 
 elements, inadequacy, obsolescence, or other functional depre- 
 ciation. In addition, in the case of a limited franchise, or otiier 
 similar limiting circumstance, the annual operating expenses 
 must include an amount sufficient to provide an amortization 
 
 ' Spring Valley Water Works vs. the City & County of San Francisco, 82 Cal. 300. 
 2 Chicago, etc., R. R. Co. vs. Dey, 35 Fed. Rep. 866. 
 6
 
 82 VALUE FOR RATE-MAKING 
 
 fund that will return to the owner the full value of his property 
 at the expiration of its term of service. 
 
 In considering the fair return to be allowed investors of public 
 utilities, the best present-day practice bases such return upon 
 the fair present value of the property. This fair present value 
 has too commonly in the past been taken to include but little 
 more than the physical, structural property. Recent decisions 
 of regulating bodies and the reviews of these matters by the 
 courts, recognize that a return must be allowed not only on the 
 value of the physical plant, but also upon that expenditure which 
 may fairly be considered necessary for developing the revenue 
 and attaching the business to the plant. 
 
 Surprising as it may seem, the authorities have held in a 
 number of cases that the value of the property and the rate of 
 return are interdependent, but any such views are erroneous. 
 Mr. R. H. Whitten, largely voicing the views of the Public 
 Service Commission, First District, State of New York, says: 
 
 "Value in a rate case is the amount on which the fair return should 
 be allowed, in order to adequately compensate the investor. The 
 essential thing is not the value alone or the rate of return alone, but 
 the net income, which is the product of the two. So long as the net 
 income remains unchanged it is immaterial, so far as the justice of the 
 result is concerned, whether cost of creating a paying business is taken 
 care of by increasing fair value and reducing fair rate of return or by 
 increasing fair rate of return and reducing fair value. A reasonable 
 net income is the fundamental requirement."^ 
 
 Mr. Whitten speaks from the viewpoint of the public without 
 due consideration of the effect of such basis of fixing rates from 
 the investor's standpoint. Mr. Whitten's statement is true in 
 the long run only as regards the consumer. A sudden change 
 in the prevailing rates for money, as has been witnessed re- 
 cently by the outbreaking of the European war, entitles a utility 
 immediately, without time for a revaluation, to a larger rate of re- 
 turn on the value of its property, which therefore must be at 
 all times the fair and proper value. The universal tendency is 
 to gradually reduce the rate of return as public utility properties 
 develop, become more stable and the cities in which they are 
 located increase in population and importance. If then, the 
 value of the property has been fixed unfairly low, with the thought 
 
 • Valuation of Public Service Corporations, page 507.
 
 FAIR VALUE FOR RATE-M AKI M; 83 
 
 that the net income allowed is the same, because of a somewhat 
 higher rate of return, the reduction in the rate of return to wlial, 
 in the future, may be considered fair by some other reKulatiiijr 
 body, or enforced as a minimum by a court in order to prevent 
 confiscation, will yield an unfairly low income as compared with 
 what that income would have been had the full, fair value of t he- 
 property always been recognized and allowed. 
 
 Along the same line of erroneous reasoning, the Public iServicc 
 Commission, First District, State of New York, in substantiat- 
 ing the value allowed in the Queens Borough case says: 
 
 "The data used to determine existing depreciation (and therefrom 
 the present value of the property) have been used to fix the amount that 
 should annually be set aside, out of earnings, to meet accruing deprecia- 
 tion. If the above estimate is too low, then the annual payment is too 
 low. But if the above estimate is too low, then the present value 
 is too high and the amount to be accepted as a fair return on 'fair 
 value' should be reduced."^ 
 
 Failure to appreciate the absolute separation of rate of return 
 from fair value fails to afford equity to the investor. The proper 
 rate of return for a given case should be determined not only 
 from the consideration of the local rate for money and risk of 
 the particular enterprise under consideration, but there should 
 also be included an allowance that will encourage efficiency 
 and enterprise. 
 
 The remarks of Edward M. Bassett, then a member of the 
 New York Public Service Commission, First District, in an 
 address delivered by him on Dec. 10, 1910, before the Brooklyn 
 Company Section of the National Electric Light Association, at 
 its regular monthly meeting, are very much in point : 
 
 "Efficiency in a public-utiHty corporation redounds not only to 
 the benefit of the public, but should redound to the benefit of the cor- 
 poration itself. The saving that comes from thrift, the greater earning 
 capacity that comes from ingenuity and faithfulness, is properly divided 
 between the public and the corporation itself, not forgetting the payment 
 of good wages and the making of permanent and promising positions 
 for those that contribute to that result. I for one am of the opinion 
 that public regulation should incite and increase and encourage private 
 initiative, thrift, economy, better results for a certain amount of work, 
 more electricity for a certain number of pounds of coal, and that 
 
 I In the matter of the Gas & Electric rates charged by the Queens Borough Gas & Electric 
 Company, Vol. II, P. S. Comm. Reports, 1st Dist., Sept. 1909-Dcc. 1911. page ■>li2.
 
 84 VALUE FOR HATE-MAKING 
 
 that efficiency should not entirely or anywhere near entirely be taken 
 advantage of by the public, but the corporation that can produce results 
 is entitled to a large measure of the benefits of its own efficiency and 
 progress. 
 
 "Public regulation will in no sense be a success until that principle 
 is largely recognized, because you cannot make all companies the same. 
 If you try to make all the same it will be pressing down the capacity 
 to the level of the poorest rather than raising up, or the endeavor to 
 raise the capacity of all to that of the highest, and profit for the investor, 
 payment of good wages, and the ability to pay good wages to the work- 
 man, must be encouraged by the State, representing all the people." 
 
 That the highest authorities recognize the necessity for 
 varying the rate of return — independently of the value of the 
 property— is shown by the decision of the United States Circuit 
 Court in the Minnesota Rate Cases in these words: 
 
 "The legal rate of interest on a debt in Minnesota, in the absence of 
 contract, is 6 per cent., and by contract it may be 10 per cent, per annum. 
 Rev. Laws Minn., 1905, Sec. 2733. Rational investments in agriculture, 
 manufacturing, mercantile, and other industrial pursuits, and even 
 well-secured loans, yield returns in Minnesota corresponding with these 
 lawful rates. 
 
 "It is an axiom in economics that the greater the risk the greater 
 must the returns be upon invested capital, and the conclusion is ir- 
 resistible that a net return of 7 per cent, per annum upon the respective 
 values of the properties of these companies in Minnesota devoted to 
 transportation is not more than the fair return to which they are en- 
 titled under the Constitution of the United States. ""^ 
 
 One of the latest and clearest opinions of any State court, 
 bearing on this subject, is that rendered in the Passaic case, 
 where a decision by the Public Utility Commission of New 
 Jersey was appealed by the corporation to the Supreme Court. 
 
 "To induce investment and continuance of capital there must be 
 some hope of gain commensurate with that realizable in other business. 
 The mere assurance that the investment will not be confiscated would 
 not suffice."^ 
 
 EflSicieiicy in Operation and Utilization. — The value of service 
 rendered to the public by a given physical plant is determined 
 not alone by the actual cost of that plant, but as much or more 
 by two other factors. These are: 
 
 ' Shepard vb. Northern Pacific Railway Co. et al, 184 Fed. 816. 
 
 ' Public Service Gas Co. vs. Board of Public I'tility Comniission et al, 87 Atlantic 655.
 
 FAIR VALUE FOR RATE-MAKINCi 85 
 
 (rt) Efficiency in operation. 
 
 {h) The degree of effective utilization. 
 
 The many questions involved in ascertaining the fair value of 
 the property has resulted in many instances in failure to properly 
 analyze and determine whether or not the operating expenses 
 are such as may properly be allowed, or whether they indicate 
 efficiency and a high degree of business acumen. It is rather 
 common practice to assume that the operating expenses in any 
 given instance are normal, possibly making some slight correc- 
 tions by additions or deductions for items not properly charged 
 and then accepting such operating expenses as proper and un- 
 worthy of further consideration. The acceptance of any such 
 principle, while not affecting the value of the property being 
 appraised, does not recognize the difference between inefficient 
 and the most advantageous management. In fact, such treat- 
 ment of operating expenses puts a premium on indolence, ex- 
 travagance and inefficient management, because there is no 
 inducement to reduce expenses to a minimum, or to seek improved 
 methods that will make "two blades of grass grow where one 
 grew before." Efficiency in operation should be rewarded by 
 allowing a rate of return higher than normal, but that is distinct 
 and apart from foresight or sagacity that obtains for utility 
 property advantageous conditions, gifts of real estate, privileges 
 or rights that to-day cannot be duplicated, all of which represent 
 value in the markets of the world, and hence are a part of the 
 fair value on which rates are to be based. Therefore, while the 
 term valuation is often taken to relate exclusively to property, 
 tangible or intangible, which is attained through the expenditure 
 of money, fair values should recognize not only the value of 
 property obtained through the investment of cash, but also 
 that produced by the effort and brain capacity of corporation 
 management. 
 
 If the lowering of rates for service to the public is the only 
 result of lower cost and increased efficiency — through adapta- 
 tion of new arts and methods in production, the application of 
 the highest business acumen, the development of the highest 
 efficiency among the employees by the cultivation of an unusual 
 esprit de corps, the maintenance of physical property in the con- 
 dition to secure best economy — then the incentive to this re- 
 sult will be removed. Investigators of the results of govern- 
 ment ownership very generally agree that incentive to progress
 
 86 VALUE FOR RATE-MAKING 
 
 is largely lost through failure to recognize the individual efforts 
 that result in improved service or efficiency of operation. Proper 
 rate-making must recognize these facts and reward owners and 
 operators of public utilities in proportion to their interest, 
 cooperation and success in rendering improved service^ with 
 corresponding efficiency. 
 
 The recognition of these facts may complicate the basis upon 
 which rates are to be determined, but that can hardly be used as 
 an excuse for the omission of this very important element in 
 rate-making. 
 
 The efficiency of operation must be determined from a con- 
 sideration of the existing local conditions and a knowledge of 
 what may be accomplished by the use of intelligent management 
 employing modern methods. The efficiency of two plants, 
 identical in size, equipment and managerial skill, may be quite 
 different under different conditions of loading. Compare two 
 electric light plants, one of which with a load factor of 50 per 
 cent, is enabled to produce its energy, per unit delivered, at a 
 very much lower rate than a second plant having the same equip- 
 ment, fuel, employees and management, but with a load factor 
 of 25 per cent. There are actual physical conditions and laws 
 which, despite the clamor of the public for reduced rates or the 
 utmost endeavors of utility management, will not prevent a 
 higher fair rate in one case than in another. Therefore, effi- 
 ciency of management ought properly to be considered, de- 
 termined and rewarded for each utility, separately, in fixing its 
 rate of return. 
 
 Value of Service. — Consideration of the value of service as a 
 factor in rate-making is not a new theory. One of the more 
 recently inaugurated State Commissions has fully discussed 
 the subject and approved the theory in the following illuminating 
 statement: 
 
 "In short, from the standpoint of what traffic will bear, a sufficient 
 and legitimate doctrine if properly understood and circumscribed but 
 not as usually urged by the carriers, the apportionment here must fall, 
 for the limiting maximum rate beyond which the carrier may not go 
 and hold his traffic is always the amount the patron can afford to pay, 
 while the limiting minimum rate below which the carrier cannot afford 
 to do the business is the actual added cost to the carrier of sucli business 
 over the cost which such carrier must, for other and independent reasons, 
 incur. In short, it has appeared to us that both the courts and com-
 
 FAIR VALUE FOR RATE-MAKJXd S7 
 
 missions have been in error in determining the lowest rate that a 
 utility may reasonably and lawfully afford. This rate, the courts and 
 commissions to the contrary, notwithstanding, may be, and often is, 
 below the actual cost of performing an average unit service. For 
 example, in the case of a hydroelectric company, it may be that the 
 actual units of power available, cost, unit for unit, a certain amount in 
 actual out-of-pocket expenditure. Therefore, if we view this subject 
 superficially, we would immediately say that this company could not 
 afford to furnish its commodity at a less rate than the actual out-of- 
 pocket cost per unit. But, on inspection, it may appear that by reason 
 of the impossibility of operating in every instance to maximum efficiency, 
 there is excess property and excess expense incurred in performing the 
 total service performed at any one time which will not be ai^preciably, 
 if at all, increased by performing some additional service. Therefore, 
 when it becomes a question of performing or not performing the ad- 
 ditional service, under the circumstances stated, the utility does not 
 and should not look to the average expense of performing the unit of 
 service, but look to the added cost arid the added revenue alone, which 
 added cost may be much less than the average cost per unit and which 
 added revenue may be less than the average revenue that must be re- 
 quired per unit. Therefore, in determining whether or not such added 
 business shall be done, the considerations we have herein discussed are 
 the ones a wise economy will require to be studied."^ 
 
 The Interstate Commerce Commission has recognized this 
 principle in its decisions where, for example, it says: 
 
 "while in fixing reasonable rates and relative rate adjustments, distance 
 must always be considered as bearing, both upon cost to the carrier 
 in performing the service and the value of the service to the shipper. 
 There are many other facts such as density or sparsity of traffic over 
 and along the lines of movement, comparative cost of construction and 
 operation, and competitive conditions, which must be given weight. "- 
 
 "The value of the services in themselves is to be considered and not 
 exceeded. These views seem to be consonant with reason. They are 
 also established by the highest judicial authority in our country."^ 
 
 One of the Massachusetts commissions, the Board of Gas & 
 Electric Light Commissioners, recognize that rates may have to 
 be less than the cost theory would dictate, in order to secure the 
 business, in the following language : 
 
 "The company's customers may be broadly divided into two groups, 
 those who are dependent upon the company for their supply and those 
 
 • Southern Pacific Railway. 
 
 ^ Union Tanning Co. vs. Southern Railway Co.; decided Feb. 4, 1913. 
 
 " Kennebec Water District vs. City of Waterville et al, 97 Me. 210-202.
 
 88 VALUE FOR RATE-MAKING 
 
 who may readily supply themselves in other waj's or by other forms of 
 power. To the first the company may dictate the price, controlled 
 only by motives of business expediency, its own sense of justice and its 
 duty as a public servant. To the second the company must so fix 
 the price as to secure the customer's business or else go without it. 
 The variety and wide range of the prices offered by the company are 
 ample evidence to its recognition of these facts."^ 
 
 The Wisconsin Commission has recognized the value of ser- 
 vice as an element in fixing rates, authorizing rates for service in 
 a number of instances at less than cost determined from a 
 consideration of investment, notably in the Madison Case, where 
 the Commission says: 
 
 "The contract for this current (sold to a street railway company), 
 was taken by the respondent on terms that, on the ordinary basis of 
 figuring, yield very little in the way of profits. In fact, it appears to 
 have been taken on the additional cost basis. That is, the respondent, 
 in taking it, based its conclusion largely on the increase this additional 
 business would cause in its operating expenses. It apparently had to 
 adopt this course because the business could not be had on better terms, 
 and on the theory that it was better both for itself and the rest of the 
 consumers to take on the street railway, even if the income from it 
 yielded less than the average rate of return on the investment."^ 
 
 "The demand expense for the station was apportioned between arc, 
 incandescents, power, and railway, on the basis of the average demands 
 on the station by each of these four branches of the service at the times 
 of the maximum demands on the station as a whole. This unit was used 
 because the facts indicate that it appeared to be logical as well as fair. 
 The output expense for the station was allotted to the arc, incandescent, 
 and power on the basis of current generated, while to the railway it was 
 allotted on the basis of the cost of additional business. The kilowatt- 
 hours of current generated appear to be the proper basis upon which to 
 apportion output costs, while the additional business basis can only be 
 justified under special or rather exceptional conditions. * * * 
 
 "It is for these reasons, mainly, that in computing the cost for the 
 railway' department we confined ourselves mostly to such expenses as 
 were added to the operation of the respondent's plant by taking on the 
 business of the street railway. This basis for fixing rates, however, has 
 well-defined limitations. It would seem that it can be justified only in 
 cases where the additional business can be had on no better terms and 
 where these terms are such as to yield something in the way of profit 
 
 ' Report of Board of Gas and Electric Light Commissioners of Massachusetts, 1913. 
 State Journal Printing Company vs. Madison Gas and Electric Company, 4 W. R. C. R., 
 page 670.
 
 FAIR VALUE FOR RATE-MAKING 80 
 
 and are not unjustly discriminatory. That it would not he sound 
 practice, from the point of view of either business or puljlic j)olicy, 
 to accept such additional business at rates that would not cover the 
 additional cost of taking it on, when this cost includes ordinary operat- 
 ing items which are affected, together with taxes, depreciation and 
 something in the way of return on the investment, needs no argument. 
 While in this case the rate paid by the street railway company is low, 
 it is probably not so low as not to come within this rule. Had the street 
 railway been charged the full proportion of all the expense items, in- 
 cluding taxes, depreciation and interest, but omitting general expenses, 
 the cost for the street railway on the basis of apportionment used here 
 would have amounted to about $30,232. "^ (Found by the Com- 
 mission, $19,254.99 Ed.) 
 
 Both the Public Service Commission of Washington and 
 the Supreme Court of that State held that the value of the 
 service must be considered in fixing rates. The Commission in 
 a recent case has said : 
 
 "In this case as in all rate cases, there are two factors wliich must 
 be given consideration, to wit: 'The cost of furnisliing the service' 
 and 'the value of the service to the patron.' What we have said thus 
 far bears particularly on the first factor. The other factor cannot be 
 ignored particularly when as in this case the opinion of the Railroad 
 Commission and that of the Supreme Court show that the value of the 
 service to the patron w^as given great, if not controlling, weight by the 
 Railroad Commission in making the orders we are now asked to vacate."* 
 
 The Supreme Court said: 
 
 "Hence, in determining the reasonableness of railway' rates, con- 
 sideration must be given, not only to the carrier, but to the individual 
 requiring the service. The company is entitled to adequate recompense 
 for the service it performs. The individual is entitled to a rate that 
 he can reasonably afford to pay for the service he requires. Upon this 
 point, both judicial and economic authority agree. (Page 84.) 
 
 "From these authorities, the true rules can be gathered, that rates 
 can go no higher than the service is reasonably worth to the public 
 requiring the service, and that the reasonable value of the service to 
 the public may be insisted upon, even though charges so limited would 
 fail to produce a fair return to the carrier upon its investment."^ 
 (Page 87.) 
 
 > State Journal Printing Company vs. Madison Gas and Electric Company, 4 W. R. C. R.. 
 pages 665-6, 671. 
 
 ^The Public Service Commission of Washington vs. Puget Sound Electric Railway- 
 cases 74-76, page 118, 4th Annual Report of the Public Service Commission of Washington. 
 
 ' 65 Washington Reports 75.
 
 90 VALUE FOR RATE-MAKING 
 
 Interest and Reward. — In the present rapid development of 
 the principles of rate-making, there has been but little recogni- 
 tion of reward or profit as distinct from interest on the value of 
 the property used in rendering public service. Capital lying 
 idle in a bank is normally entitled to the ruling rate of interest 
 in the particular locality in which the capital is available, but a 
 similar payment of interest upon investment, intelligently and 
 fairly made in any going enterprise, is not in any way a fair return 
 to the originators, or owners, of the enterprise in payment for 
 their making such investment, assuming the risk of such utility, 
 and displaying the ability or rendering a service in carrying on 
 such business. 
 
 Capital is entitled to a definite return in any given locality, 
 regardless of its use; enterprise results in efficient handling of 
 capital and is, therefore, entitled to its own specific reward, 
 dependent in amount upon the grade of efficiency developed. 
 
 In considering the charges that should properly be paid by 
 the public for the service rendered in order to determine rates, 
 the following items should be included : 
 
 First. — Operating expenses, including such items as fuel, labor, 
 management expenses. 
 
 Second. — Taxes. 
 
 Third. — Depreciation, including : 
 
 (a) Ordinary wear and tear. 
 
 (&) Renewals and replacements. 
 
 (c) Reserves for accruing exhaustion of property. 
 
 {d) Inadequacy and obsolescence. 
 
 Fourth. — Amortization, or sinking funds, where necessary to 
 provide for the extinguishment of investment, as in the case of 
 limited franchises. 
 
 Fifth. — Return proper for local conditions on the value of the 
 property fairly required in carrying on the enterprise. 
 
 Sixth. — Reward, or profit, to the owners. 
 
 It has been customary in most decisions of commissions and 
 courts to allow merelj^ a "fair rate of return," upon the value of 
 the property including in the rate what is here divided 
 into interest and profit. The trouble with this procedure of 
 public authorities is that it fails to properly recognize the two 
 classes of reward; one for investment, and the other for enter- 
 prise. Both rewards are usually rolled into one, too rarely 
 exceeding a fair rate of interest.
 
 FAIR VALUE FOR RATE-MA KTXC 01 
 
 The fallacy of attempting to fix the rate of return to he allitwcl 
 a public utility, merely from a consideration of the amount of 
 capital expended, would mean that the coiporation with the most 
 elaborate and costly installation would be entitled to the largest 
 revenues, while a less pretentious, but more intelligently planned 
 and economically constructed property, doing as large or a 
 larger business, would in effect be penalized for their greater 
 effectiveness in design and ability to attract and hold business. 
 Such basis of valuation would moan that with the same return 
 allowed upon investment, the most economically constructed 
 property would of necessity make lower tariffs, and, consequently, 
 would tend to secure all the business, leaving the more costly 
 property without sufficient revenue to meet even operating ex- 
 penses. The truth of this line of argument is recognized in the 
 making of steam railroad rates to competitive points, where 
 the amount of investment is not made the basis of rates. De- 
 velopment and initiative ability are recognized as entitled to 
 rewards, otherwise, there would be no improvements, or any in- 
 ducement to development and improvement. 
 
 A very common method of carrying on building operations 
 is to employ a contractor who is paid the actual cost incurred in 
 purchase of materials, labor and other expenses of building the 
 structure, plus 10 to 20 per cent, to cover the cost of his services, 
 ability and management. The contractor may have no plant 
 equipment of his own, or in any case his investment in such plant 
 as might be necessary for the construction of the property in 
 question would be but a relatively small amount, and a return 
 on such contractor's plant would in no way compensate him for 
 his time and ability. The contractor is paid his percentage on 
 the amount of his "turn-over;" that is, the sum of the expendi- 
 tures made for material and labor in completing the structure. 
 
 A reward, which may properly be called a "commission." 
 based upon the amount of business done, that is, ujjon \ho 
 revenue, permits a uniformly applicable and exact ascertain- 
 ment of that reward wdthout regard to the amount of capital 
 invested. By way of illustrating one set of conditions, take 
 the case of two non-competing utilities having the same amount 
 of annual gross revenue, they would be allowed the same rate, 
 or percentage as commission, on account of the business done. 
 Assuming that one of the utilities is required by the necessity ()f 
 its business to invest a large amount of capital as compared witii
 
 92 VALUE FOR RATE-MAKING 
 
 the other, then both will be allowed (under the same local 
 conditions) the same rate of return upon the capital invested, 
 but the company having the greater capital investment receives 
 a total aggregate amount, as its annual return, larger than the 
 other company, which is both fair and reasonable. If the 
 conditions are different, both utilities having property of equal 
 value, but the first does twice the annual business of the second, 
 then the rate of return on capital being the same, the aggregate 
 amount received annually by each as interest, is the same, but 
 the commission received by the first utility will be twice that 
 received by the second, both being allowed the same rate or 
 percentage on their gross revenue, thus the second, by reason 
 of more effective utilization will receive the greater gross re- 
 turn. For the sake of simplicity, no mention has been made, in 
 the preceding illustrations, of the profit which should or should not 
 be allowed the utilities, but which, of course, must be inde- 
 pendently considered and determined. It may well be that while 
 interest, profit and commission are each fixed separately for 
 any given utility, their sum may actually or approximately 
 equal the sum of like allowances for another and different 
 utility, that is no reason why each case should not be logically 
 and equitably decided upon its own considerations, for "there 
 is no necessary relation between a 7 per cent, return on capital, 
 and a 10 per cent, return on income." 
 
 The proposal to analyze and divide into its components the 
 total reward to be allowed utilities, may at first sight seem com- 
 plex and unnecessary, but in order to insure justice and a proper 
 consideration of all elements making up the rate of return, it 
 is believed the separation of interest as distinct from profit, and 
 both from commission, permits a clearer appreciation of what 
 is being considered, makes easier a comparison with what corre- 
 sponds to rewards allowed in ordinary commercial transactions, 
 and allows a fairer determination of the amount of return proper 
 for each class of service. 
 
 "To illustrate a rational method of determining reasonable profits, 
 let us take the steam railways of America, and let us assume that the 
 capital invested in their construction and equipment is $45,000 per mile 
 of roadbed. Then, according to data given in the Interstate Commerce 
 Commission Report for the year, 190G, and upon this assumption of 
 first cost, we have:
 
 FAIR VALUE FOR RATE-MAKING 93 
 
 Per mile of road 
 
 Operating expense (including renewals) SG.SiXi 
 
 Taxes 337 
 
 Interest on $45,000 at 43-^ per cent 2,025 
 
 Total cost of production $9,258 
 
 Operating revenue 10,460 
 
 Deduct cost of production 9,258 
 
 Profit $1,202 
 
 "This profit is about U^ per cent, of the operating revenue. It 
 is not quite 2.7 per cent, of the assumed investment of $45,000 per mile. 
 Hence the total return on capital — viewing the matter from the old 
 standpoint — is 2.7 per cent, profit and plus 4.5 per cent, interest = 7.2 
 per cent. 
 
 "It may chance, therefore, that a 7 per cent, 'return on capital' in- 
 vested in railways gives a true profit of 10 or 11 per cent, on gross income, 
 and that this return is reasonable in that such managerial ability is 
 suitably rewarded by its 10 per cent, profit; but there is no necessary 
 relation between a 7 per cent, 'return on capital' and a 10 per cent, 
 return on income."^ 
 
 As indicating other elements than mere value of property or 
 investment, mention is made of the following considerations that 
 should be given weight in steam railroad rate-making. 
 
 Economies and lower rates for service have resulted from 
 developments, improvements and inventions that must be 
 credited to aggressive, efficient management; for example, the 
 use of large freight cars has amply demonstrated their economy. 
 Fifty years ago, a 15,000-lb. freight car indicated what was normal, 
 whereas the present representative cars have a capacity of from 
 80,000 to 100,000 lb. This means that very much greater carrj^- 
 ing capacity is obtained by a comparatively small increase, not 
 only in operating expenses, but also in fixed charges, which are 
 a relatively much smaller investment per unit transported. 
 Train loads which for long hauls may now be perhaps con- 
 sidered standard at 2,000 tons were almost unthought of only 
 a dozen or fifteen years ago. The economy of all locomotive 
 operation has been largely improved during the last 10 or 20 
 years due, not only to improved efficiency and power of the 
 locomotives themselves, but by reason of their more intensive 
 use, resulting from better and more intelligent supervision. 
 
 ^Engineering-Contracting, May 25, 1910 (pages 467-8), pertaining to "A rational 
 method of determining reasonableness of rates charged by Public Service Corporations and 
 a discussion of the theory of profits."
 
 94 VALUE FOR RATE-MAKING 
 
 As illustrating the reductio ad absurdum to which the stead- 
 fast and logical adherence to the principle of allowing returns on 
 only the value of physical property, the decision of the Rail- 
 road Commission of California, in the matter of rates of charges 
 authorized the Wells Fargo Express Company, is illuminating. 
 
 The capital invested in the physical property of the express 
 companies is relatively small compared with the service rendered 
 or the gross revenue received therefrom, because the transporta- 
 tion is done mainly by the railways. The recent decision of the 
 Interstate Commerce Commission seriously reducing all express 
 rates seems to have failed in making due allowance for the reward 
 for service. The same views, that return on the value of the 
 physical property only, should be allowed the express companies, 
 is shown by the recent decision of the Railroad Commission of 
 California. 
 
 This Commission in determining the revenue, operating ex- 
 penses, net income and value of the physical property, of the 
 Wells Fargo Express Company used for intrastate business in 
 California, in 1911, arrived at the following figures: 
 
 Gross revenue $4,508,436 
 
 Operating expenses, payments to railroads for 
 
 transportation 1,937,019 
 
 Terminal expenses 1,343,108 
 
 Overhead expenses 89,733 
 
 Line expenses 294,127 
 
 Miscellaneous 266,027 
 
 $8,438,450 
 Less deductions 105,745 
 
 $8,332,705 
 Net income 684,165 
 
 $7,648,540 
 
 In arriving at the above figures, showing a net income of 
 $684,105, more or less arbitrary assumptions were made as to the 
 division of expenses of an interstate and intrastate business. 
 On the basis of certain other assumptions the Commission found 
 the net income from intrastate business to be $842,097 and upon 
 still slightly different assumptions it found the net income to 
 be $695,691. From a consideration of these three results and 
 the value of the physical property as found by it to be $613,233,
 
 FAIU VALUE FOR RATE-MAKING <»-) 
 
 the Commission concludod that $61,323 should be taken as the 
 fair net income from intrastate business properly allowable U)y 
 the year 1911, concluding with the following: 
 
 "We have already found that the net revenue from California intra- 
 state transportation business during the year here considered was not 
 less than $684,165.90, which represents a little more than 111 per cent, 
 of the total value of the company's property devoted to the public 
 service in this State, conceding to the company practically everything 
 it asks; or, taking the second method of apportionment, the net earning 
 is in excess of 136 per cent. 
 
 "Allowing the company 10 per cent, on the basis of valuation of its 
 property of $613,233.85 gives a charge of $61,323.39 as the earning to 
 which the express company is entitled after paying all of its operating 
 expenses, taking care of depreciation and all charges necessary and 
 proper in the conduct of its express business, and we shall prescribe 
 rates which will allow the express company all of its charges to the 
 railroads, its legitimate operating expenses, all of its other legitimate 
 charges, including depreciation, and $61,323.39 as a net earning upon its 
 property."^ 
 
 On the basis of the above, the Commission ordered the 
 company to put in force a schedule of rates, or tariffs, promul- 
 gated by the Commission, which were planned to reduce revenue 
 in line with the above quotation. 
 
 The reasonableness of attempting to fix a net income of 
 $61,323 as being a fair return merely on a physical property may 
 be questioned when it is considered that this sum is obtained 
 by approximate methods and based on revenues of over 
 $4,500,000. In ordinary engineering calculations 1 j^er cent, is 
 considered so small an item as to be practicably negligible, yet 
 a reduction in the net income of the express company of less 
 than 13-^ per cent, would entirely wipe out all return to the 
 owners for the use of their property. The net income from 
 intrastate business was found to be as small as $684,165, or 
 as large as $842,097, depending on the methods used; a varia- 
 tion of $157,932, evidently, merely an approximate figure, yet 
 no reward was considered necessary for the business acumen, 
 ability or the "going value" of the corporation, which peruiits 
 it to develop a business having a revenue of over $4,50(),()()(). 
 Such slight margin as $61,323 on a revenue of $4,508,436, is so 
 
 1 Report of Railroad Commission of California, Decision No. 841, In the Matter of tlip 
 Schedules or Tariffs of Rates of Charges of Wells Fargo Co., Case No. 122.
 
 96 VALUE FOR RATE-MAKING 
 
 small and is so likely to be jeopardized by absolutely uncan- 
 troUable variations in business that the regulation of utilities 
 on any such basis must result not only in the refusal of addi- 
 tional capital to enter such enterprises, but the confiscation 
 of present invested capital and confidence. 
 
 The impossibility of determining proper tariffs from a con- 
 sideration merely of the value of the property used in render- 
 ing the service is recognized by the Railroad Commission of 
 Wisconsin, which, perhaps, as much as any other Commission 
 or public authority, is definitely committed to the use of the 
 value of the property used in fixing rates. 
 
 "It has also been the contention of representatives of localities along 
 certain lines, and even along sections of such lines, comprising the entire 
 interurban system, that the patrons of those separate lines or sections 
 of lines having a higher traffic density and operating upon a better 
 revenue basis should be granted fares lower than the fares computed 
 upon a mileage basis. It is difficult, however, to see the justice of es- 
 tablishing such fares, especially when it is the object of this revision of 
 existing rates to abolish, so far as practicable for the present, all special 
 fares involving local discrimination. It is also the object of this revision 
 of rates to bring about simplicity, uniformity and stability in the 
 rate schedules applying to these lines by disregarding any differences in 
 revenues or operating conditions. This is in line with the more modern 
 theory of transportation rates. Take, for example, the regular passenger 
 fares upon the steam lines within the state. The basic rate is 2 cts. 
 per passenger mile and with few exceptions the fares are computed 
 accordingly whether the company is large or small, whether the haul 
 is long or short, whether the traffic is profitable or unprofitable, or 
 Avhether the service is poor or excellent. If all these factors cited should 
 be reflected in full force in the rates the probability is that the rates 
 would vary all the way from 0.5 ct. per mile to 50 cts. per mile. But 
 the nature of the transportation business is such that the demand for 
 complicity, uniformity and stability is necessarily controlling because 
 even a slight variation in basic rates would open the way to uncertainty 
 in the minds of the riding public and would result in personal and local 
 discrimination."' 
 
 While in every case, where the rendition of service is concerned, 
 
 the greatest use of property, reasonably obtainable, should be 
 required, yet a difference in the habits of the citizens, the number 
 and type of manufacturing concerns, and other local conditions 
 
 • Opinion and decision of Railroad Commission of Wisconsin, Robert S. Schmieder et al. 
 VB. Milwaukee Light, Heat & Traction Co., decided Jan. 2, 1914. 13, W. R. C. R., 489.
 
 FAIR VALUE FOR RATE-MAKING 07 
 
 prevent the establishment of a minimum "load factor" as uni- 
 formly attainable, and compels its determination in each in- 
 dividual case. To further illustrate the unicjue condit.icjns 
 which control considerations on which to base reward, take I ho 
 case of an actual electric light and power utility, which origi- 
 nally located its generating station convenient to a railroad, 
 where there was an available supply of water that seemed 
 ample for years to come; with the development of the business 
 over a period of 15 years, additions and extensions to the power 
 plant were made without unreasonable accretions in cai)it;il 
 account. But as the result of progressive management, con- 
 centrated business-getting methods and the continued greater 
 use of electrical energy on the part of the public, the demand 
 upon the power station passed beyond the limit of maximum 
 utilization of the original plant and its water supply, making 
 necessary the construction of a new station at a different site 
 where there was an unlimited supply of water, and where the 
 now developed demand for electrical energy warranted the 
 building of a spur track to be used exclusively for the new 
 power plant. The new plant has cost in the aggregate nearly 
 $1,000,000, and has rendered useless the old investment amount- 
 ing to $600,000. Therefore, the proper charges to be borne by 
 the public for similar service, must now be based on the 
 $1,000,000 investment, whereas slightly less demands on the part 
 of the public permitted them to pay similar charges on only 
 a $600,000 investment. 
 
 In the case of a steam railroad handling a given amount of 
 business well below its maximum capacity, it may add small 
 increments of traffic with no increase in charges for capital ac- 
 count, and with but small increase in maintainance and operating 
 expenses: first, simply by better loading without any noticeable 
 increase in the sum total of its annual charges; second, by 
 slightly increasing the frequency of the service, with somewhat 
 larger expenses for fuel and wages, a still greater and substantial 
 increase in the amount of business can be obtained. This in- 
 crease of effective utilization can continue up to a certain point, 
 when additional locomotives and cars must be provided and 
 finally a point is reached where it is necessary to add additional 
 right-of-way and very materially add to the capital account 
 with consequent increase in fixed charges. Up to the point 
 where there is no substantial additional outlay of capital, effi- 
 7
 
 98 
 
 VALUE FOR RATE-MAKING 
 
 ciency of utilization of the property is steadily increasing with 
 increase of business, but when such efficiency has reached its 
 maximum, requiring large additional outlays for new plant, the 
 efficiency may drop to a low figure, and this result is due entirely 
 to the fact that the business has increased to just beyond the 
 limits of the capacity of the original property. Thus, at the 
 point of maximum utilization the rates that would pay more than 
 a fair return — even a handsome profit to the investors — will be 
 found inadequate to make a fair return and may even show a 
 deficit after the expenditure for the additional property invest- 
 ment required by a relatively small increase in business, beyond 
 the capacity of the original property. Consequently, it will be 
 seen that the largest tonnage per mile that a railroad can safely 
 and effectively crowd on to its line will result in the lowest 
 charges, at the same time affording proper return to the investors. 
 
 In steam railroad operation where a large proportion of the 
 total charges are constant, irrespective of the amount of business 
 done, the fixing of rates on whatever basis, particularly where 
 large consideration is given to the value of the physical property 
 alone, may result in confiscation, unless the business conditions 
 of the country at large are considered when fixing the rates. 
 
 To illustrate the unfairness of ignoring the principle of re- 
 warding enterprise in fixing rates, consider two communities, 
 "A" and "B" similarly situated, each having a population of 
 50,000. "A" has a live, progressively managed electric utility 
 with up-to-date commercial methods. "B" has similar equip- 
 ment, so far as apparatus is concerned, but it does not appre- 
 ciate the possibilities of the business. Therefore, the practical 
 results of operation are shown in the following tabulation: 
 
 Table I 
 
 A B 
 
 Capital invested , $1,57.5,000 . 00 
 
 Average sales rate {>er watt-hour 
 
 Sales per capita 
 
 Gross earnings 
 
 Operating expense (ratio 60 per cent.) 
 
 Earnings applicable to interest and taxes. . . . 
 Taxes on the basis of $5 per huiulrod gross 
 
 earnings 
 
 Earnings applicable to dividends 
 
 Per cent, equivalent on capital invested 
 
 . 04 
 
 8.00 
 
 400,000.00 
 
 240,000 . 00 
 
 160,000.00 
 
 20,000 . 00 
 140,000.00 
 
 8.7 
 
 ,125,000.00 
 
 0.06 
 
 5.00 
 
 250,000 . 00 
 
 150,000.00 
 
 100,000,00 
 
 12,. 500. 00 
 87,500.00 
 
 7.7
 
 FAIR VALUE FOU UATE-MAKl Ml 
 
 '.I'.) 
 
 "A" has used 10,000,000 kilowatts per aiuiuiii, while "li" lias lia<l 
 the benefit of only 4,106,000. "A" has received in taxes $20,000, 
 while "B" has received $12,500. In other words, "A" receives its 
 service at 33^ per cent, less than "IV and is well served and well 
 satisfied, while "B" is not satisfied wdth either its service or its rates, 
 although the capital invested in the enterprise is receiving a less return 
 than that invested in "A." 
 
 The conditions cited are not at all exaggerated, and the repcjrts of 
 the Public Service Commission for the last six years will show similar 
 cases. 
 
 Let us assume in the example cited above that the Commission stands 
 on the ruling that all companies shall be allowed to earn 8 per cent, 
 and no more. "A" has in this case a return of %q per cent, greater 
 than it should have, although it is furnishing nearly two and a half 
 times the service and at one-third less rate than "B," and is paying 
 $7,500 more per annum in taxes. "B's" rate under the same ruling 
 is too low, and should be raised sufficiently to bring in a return of 8 per 
 cent, on the capital invested. 
 
 Until the present era of public utility regulation, the theory 
 has never received serious consideration that dollars invested, 
 practically without regard to the human ingenuity, efficiency 
 and industry expended thereon, should be made the measure of 
 reward. To-day, however, there are many advocates of this 
 theory, and courts and commissions are holding that the value 
 of the property entitles the owner to a rate of return, without 
 reference to whether the owner uses that value indolently or 
 aggressively. Much present-day thinking in relation to utilities 
 seems to have lost sight of the fact that the ability to do business 
 and render service is entitled to reward, even though there be 
 little or no property employed therein. Yet, in practically all 
 other lines of business, such rewards are conceded. 
 
 A merchant figures his profit on a percentage of the sales, 
 not upon the value of his stock on hand. He turns over his stock 
 several times each year and the more times that he can turn it 
 over, the greater his profit, and this is as it should be, because 
 "the harder money is made to work" the greater should be the 
 reward to the owner. 
 
 ' J. T. Hutchings, General Manager, Rocliester Railway & Light Company, before the 
 New York State Waterways Association, June, 1914.
 
 CHAPTER V 
 COST OF REPRODUCTION 
 
 Development of Theory. — A consideration of the conflicting 
 views and many theories promulgated for determining value 
 leads many a practicable mind to turn to actual cost in money 
 as the proper measure of value. To the lay mind it would seem 
 as if the basis for rates might well be made the amount of money 
 expended for the benefit of the public. But it will be imme- 
 diately recognized that a part of the money spent may have been 
 expended recklessly, improperly, or for property which is no 
 longer in existence. A common experience will indicate that 
 cost does not necessarily indicate present value. Present value 
 may, on the one hand, be much less than cost if property has been 
 allowed to depreciate, has been injured by accident, exhausted 
 by service or wrecked by mismanagement, on the other hand, it 
 may be more than cost if property has increased in value through 
 appreciation of real estate, improvement of operating conditions, 
 superior management or desirable location. As a matter of 
 fact the greater the separation in point of time, between cost and 
 the date of valuation, the greater the difference may be between 
 expenditure and value. When the date of cost and the date of 
 value to be determined are the same, expenditure honestly and 
 intelligently made is a fair measure of value. This latter con- 
 sideration has lead to the very general acceptance of the cost of 
 reproduction theory in determining the present value of any 
 property. 
 
 It is a method universally applicable for determining the 
 existing or present-day value of utility property, because it 
 furnishes an estimate of the cost of producing a like property at 
 to-day's costs. 
 
 "Reproduction cost is based upon the assumed recreation or sub- 
 stitution of an identical new plant at present prices according to the 
 existing apparatus, specifications, assuming reasonable diligence and 
 methods and a reasonable period of time in construction. "^ 
 
 ' Mr. W. H. Blood, testimony before Public Service Commission of Missouri, October, 
 1913. 
 
 100
 
 COST OF REPRODUCTION ]n\ 
 
 An attempt to ascertain present value by modifying tin- 
 figures of original cost or investment to meet one's ideas of tlu' 
 cost of existing property is no less speculative or theoretical than 
 the determination of present value by using present-day prices 
 applied to existing property. On account of this practical 
 difficulty of modifying original cost and because of the absence 
 or indefiniteness of old records the method of using to-day's cost 
 for pricing property has been quite generally taken and accepted 
 as the most important element to be considered in determining 
 the value of existing utility property. 
 
 "The cost of reproduction of tangible property is at present the most 
 generally accepted basis of valuation for purchase or rate-making. 
 Its great advantage is that it is comparatively easy of ascertainment."' 
 
 "Reproduction cost new is the basis upon which substantially all 
 modern appraisements are made. It is the most fair, from the fact 
 that it is based upon existing conditions and it is not especially difficult 
 to determine market prices for materials and labor at the time."^ 
 
 The cost of reproduction method has been used, with some 
 differences as to detail methods and unit prices, both by the 
 experts for public authorities and the appraisers employed by 
 the corporations in ascertaining the present value of utility 
 properties. The courts themselves have sustained and approveil 
 this method. The Supreme Court, in the Knoxville Water 
 Company case, said: 
 
 "The cost of reproduction is one way of ascertaining the present 
 value of a plant like that of a water company."' 
 
 The method was also used in the Consolidated Gas case where 
 the value thus arrived at was made the basis of rates approved 
 by the Supreme Court. In the more recent Minnesota rate case 
 the Supreme Court said: 
 
 "The cost of reproduction method is of service in ascertaining tlie 
 present value of the plant, when it is reasonably applied and when the 
 cost of reproducing the property may be ascertained with a proper 
 degree of certainty."^ 
 
 The Supreme Court of Idaho has recently upheld the methods 
 of the State Utilities Commission in using the reproduction 
 
 > Whitten, "Valuation of Public Utilities," Sec. 639. 
 
 ^Foster, "Engineering Valuation of Public Utilities and Factories," page 14. 
 
 3 City of Knoxville vs. Knoxville Water Co., 212 U. S. 9. 
 
 * Minn. Rate Cases, 230 U. S. 452.
 
 102 VALUE FOR RATE-MAKING 
 
 method for ascertaining the vaUie of iitihty property in rate- 
 making, the Court saying: 
 
 "This Court is of the opinion that the rule of cost of reproduction 
 less depreciation, adopted by the commission, is the correct general 
 rule or principle to be applied in this class of cases. "^ 
 
 The Court then goes on to state that 
 
 "The worth of a new plant of equal capacity, efficiency and durability 
 * * * should be the measure of value, rather than the cost of exact 
 duplication." 
 
 explaining that the only deduction for depreciation should be 
 for 
 
 "actual, tangible depreciation, and not for theoretical depreciation, 
 sometimes called 'accrued depreciation.' " 
 
 Perhaps the best considered declaration on the subject of using 
 reproduction cost as the best evidence of present value is the 
 Federal Court's decision in the Louisville Railroad case. It 
 involved the constitutionality of an act of the legislature in 
 establishing railroads' rates, and hence is a rate case. Speaking 
 on the subject of reproduction cost, the Court says: 
 
 "In reference to the question of value with the view of rate regulation, 
 the most reliable test ordinarily is the cost of the reproduction of the 
 road as it exists. * * * The original cost of a road may in some cases re- 
 flect light on, or even determine, the present value, as when it is of very 
 recent construction. But ordinarily it is of little assistance in that 
 regard, since many items of value may be donations by the government, 
 or by individuals, as in the case of the south and north, or the road may 
 have been built long before the period of inquiry at greatly less or greatly 
 higher prices than those prevailing at the time of the inquiry. Or 
 its original cost might be involved in obscurity and may include the 
 cost of abandoned or destroyed portions of the property, which should 
 not figure in the inventory for the present time, or the road may have 
 been bought at a forced sale in times of panic at a nominal price or in 
 inflated times at a corresponding price; or the road, costing little origi- 
 nally, may have developed from many contributing causes into being 
 property of great value. And in every case, after finding the original 
 cost, when possible to be done, the question would still have to be solved 
 as to whether .such original cost is the same as the present value, which 
 would involve the determination of the present value for such com- 
 
 ' Murray vh. Puhlio I'tilities Cornrnis.sioii, ISO Pufific Itcportcr ,50.
 
 rrXST OF REPRODrcTloX ]():i 
 
 parison independent of original cost, and in no other or hettor way tlmii 
 on reproduction values."' 
 
 "It is a fair return upon the reasonable value of their Minnesota 
 property in 1908 to which these companies were entitled, and the cost 
 of that property at times varying from 5 to 40 years ago may be some 
 evidence, but it is certainly no criterion of its value in that year. In 
 view of these facts the master rightly decided that the cost of reproduc- 
 ing this property new was a more rational and reliable measure of 
 its real value than the original cost of its acquisition and construction 
 or the market values of the stocks and bonds of the companies and 
 upon such basis he made his findings. "^ • 
 
 In the Consolidated Gas Company case where the cost of 
 reproduction was made the basis of value upon which rates were 
 fixed, Judge Hough, in the course of his opinion, gave his idea 
 of the cost of reproduction as related to value in the following 
 clear language: 
 
 "It appears by undisputed evidence that some of these last items of 
 property cost more than new articles of the same kind would have cost 
 at the time of inquiry; that some of designs not now favored by the 
 scientific and manufacturing world, so that no one now entering upon a 
 similar business would consider it wise to erect such machine or obtain 
 such apparatus. In every instance, however, the value assigned in the 
 report, is what it would cost presently to reproduce each item of property 
 in its present condition and capable of giving service neither better 
 nor worse than it now does." (Page 854.) 
 
 "As to all of the items enumerated, therefore, from real estate to 
 meters, inclusive, the complainant demands a fair return upon the 
 reproductive value thereof, which is the same thing as the present 
 value properly considered. To vary the statement: Complainants' 
 arrangements for manufacturing and distributing gas are reported to 
 be worth the amounts above tabulated if disposed of (in comniercinl 
 parlance) 'as they are.' 
 
 "Upon authority, I consider this method of valuation correct.'"^ 
 (Page 855.) 
 
 "The great and substantial question of fact, in this case, is as to 
 the value of the plant. What a plant cost originally is not the measure 
 of value that courts must look to, to determine the validity of rates. 
 The value of stocks and bonds is no test, for obvious reasons, and 
 
 1 Louisville & N. R. Co. vs. Railroad Commission, 196 Fed. 820. 
 
 2 Shepard vs. Northern Pac. Ry. Co. et al., 184 Fed. 80.3. 
 
 ^ Consolidated Gas Company vs. City of New York, 157 Fed. 849.
 
 104 VALUE FOR RATE-MAKING 
 
 mere theorists only, at the present day, insist upon such as the valua- 
 tion. Practical men know that it is not the test. There can be no true 
 test, other than the physical valuation, and to such physical valuation 
 there must be added certain other items. 
 
 "This case seems to have been tried before the master, by both parties, 
 upon the reproduction theory; that is to say what this plant would cost 
 if it were blotted out of existence, and the city, or some other company, 
 were to undertake to reproduce the plant. "^ 
 
 The most important single piece of valuation work now being 
 carried on is that of the Interstate Commerce Commission in 
 valuing the steam railroads of this country. The cost of repro- 
 duction new is being ascertained, and in reply to an inquiry sub- 
 mitted by Director Prouty, representatives of the railroads stated 
 their position as follows: 
 
 "In determining the cost of reproduction new, reference shall be had 
 to the conditions as they exist at valuation date, but the historical 
 construction of the property must be taken into consideration whenever 
 a rational engineering program for reproduction would so warrant or 
 require. Conditions existing on the valuation date as to population, 
 business capacity, and productiveness and property values in the terri- 
 tory served by the carrier are to be taken. 
 
 "The same quantities and classes of grading materials which were 
 originally obtained on the right-of-way will be deemed to be obtainable 
 in the same places, and the present cost of moving the same will be 
 ascertained. The cost of acquiring other necessary materials from the 
 most available sources on valuation date will be ascertained."^ 
 
 The views of the railroads with regard to the above are further 
 explained by them as follows: 
 
 "The reproduction new cost figure thus required, represents the cost 
 of an identical reproduction of the existing plant at the present time, at 
 proper present prices, and under present conditions, the historical con- 
 struction of the property to be taken into consideration in order to aid 
 in the ascertainment of the items comprising the transportation plant, 
 or incidental to its production, quantities and the character thereof, 
 in the ascertainment of contingencies, and in the determination of an 
 appropriate economical engineering program for the reproduction of 
 the property."^ 
 
 ' Des Moines Water Co. vs. Des Moines, 194 Federal 197. 
 
 ^ Brief filed on behalf of the railroad companies represented by the Presidents' Conference 
 Committee, before the Interstate Commerce Commission, Sept. 1, 1915, pages 30 and 39.
 
 COST OF h'l<:/'ROI)('('TfOX KK- 
 
 The authorized representatives of public utility coiiuiiissions 
 of the various states having to do with railroad ijroprrties, 
 answered Commissioner Prouty's inquiry as follows: 
 
 "As a general principle, cost of reproduction new should \>v (Icter- 
 niined on the basis of present conditions." 
 
 The cost of reproduction has, in very many instances, hoen 
 used in ascertaining the value of the physical property only. 
 There is no reason why the principle and the method should not 
 be used uniformly in ascertaining the value of the entire prop(>rty 
 of any utility. In practically all valuation work the cost of re- 
 production, present-day prices, namely, the basis of a transac- 
 tion between a willing seller and a willing buyer, has been used 
 in determining the values of real estate and rights-of-way. The 
 courts have uniformly and definitely ruled that the present value 
 of land is the only value to be considered in determining the value 
 of such property of pubUc utilities. Consequently, even those 
 authorities who have adopted other bases than reproduction cost 
 for ascertaining the value of the remaining parts of the property, 
 have added to such values the present value of real estate, in 
 order to determine the total value. 
 
 It has been a very common practice in the valuation of utility 
 property to use the present cost of reproduction of physical 
 property, adding thereto the original cost of developing the busi- 
 ness, in order to ascertain the total value of a given projKM-ty. 
 This method was formerly allowed practically exclusively by tlu^ 
 Railroad Commission of Wisconsin and has the weight of court 
 approval, as shown in the following pages under "Going Value." 
 There is, however, no reason why "going value," as well as 
 other physical, non-physical or overhead charges, should not lie 
 determined by the consideration of present cost of reproduction 
 rather than historical, original cost. Certainly, from the stand- 
 point of consistency and logic, any estimate that is made up on 
 the basis of reproduction cost for the greater part of the total 
 property, should use the same uniform basis throughout ; failure 
 to apply the same standard of measurement to all parts of the 
 property might well seem to provide grounds for raising questions 
 as to the legality of any such hybrid procedure. 
 
 The two methods, cost of reproduction and original cost, should 
 be kept separate and distinct, otherwise great harm may be done 
 either to the public or to the utility. There is a tentlency among
 
 IOC, VALUE FOR RATE-MAKING 
 
 certain engineers, and, to a limited extent, in the decisions of 
 the commissioners, to confuse the two methods. Any such pro- 
 cedure is an abandonment of the reproduction method. It is a 
 mixture of that method with the original cost method. The 
 fallacy of such procedure is primarily due to the fact that its 
 supporters are trying to find one sum or cost, which alone is to 
 be considered the value of the property. But the courts have 
 decided that there shall be ascertained several different costs; 
 namely, reproduction cost, original cost, reproduction cost less 
 depreciation, and from a consideration of all of these and other 
 costs, and the exercise of a wise judgment, the fair value of the 
 property is to be determined. 
 
 Under the reproduction method, to be consistent and logical, 
 the cost should be figured or determined upon the basis of exist- 
 ing, to-day's conditions. Alongside this estimate may be placed 
 the actual original cost, if it can be determined, and the other 
 estimates based on the other lines of pertinent proof, as indicated 
 in the Smyth vs. Ames case, but there is no logical or legal warrant 
 for determining cost, as an element of value, by basing it partl}^ 
 upon the reproduction method and partly upon the original 
 cost method or basing it on present prices applied to historic 
 conditions. 
 
 Perhaps the reason for taking cost or historical values for 
 structural property and reproduction or market value for land 
 and combining such figures in ascertaining the total value of 
 utility property, may be found in the explanation made by Ex- 
 Chairman Stevens of the Public Service Commission of New 
 York, Second District, where he says: 
 
 "The land owned by the respondent consists of five distinct parcels 
 which are carried upon its books at $54,601.45, this being their cost. 
 This is the sum at which they are carried in the examiner's report. 
 Land has a value for other purposes than that of carrying on the proper 
 business of the company. It could be retired from the service at any 
 time at its market value for such other purposes. This fact differen- 
 tiates it from the property which is valuable only for company operations, 
 and it has been universally held that a company is entitled to a just and 
 reasonable return upon the present value or market value of tlie land 
 used by it in the public service. It is clearly distinguishable in principle 
 from those things which have no value except in the service of the 
 company except scrap value."' 
 
 >3 P. S. C. 2(i n. (X. V.) 0.50.
 
 CO^T OF REPRODir-TrON 107 
 
 The Massachusetts PubUe Service Coinmissioii has this I0 say 
 with regard to the reproduction cost theory: 
 
 "It is a matter of common knowledge that in Massachusetts (hiring 
 recent years this reproduction cost theory as a basis for rate-nmkiiin 
 has been urged on behalf of certain public utility c()nii):iiiios, mostly 
 gas companies that have accumulated out of excess earnings or uncarueil 
 increment upon land values, large amounts of property not represented 
 by the original capital invested or by the stocks and bonds issued under 
 our anti-stockwatering laws. 
 
 "Undoubtedly in rate cases and other cases involving the conflicting 
 rights of the rate-paying public and the investing public, the cost of 
 reproduction may frequently be a fact desirable to be ascertained, and 
 sometimes it illuminates important aspects of the problem presented; 
 it is often the best method of checking up unsatisfactory accounting, 
 particularly when dealing with depreciation. But as a fundamentally 
 controlling principle, no theory could work out grosser injustice— 
 to the rate-paying public in some cases and to the investing public 
 in other cases — than the reproduction cost theory. In cases where 
 rates have for years been too high, so that the companies have accumu- 
 lated, out of excess rates paid by the public, large amounts which have 
 gone for capital purposes, this theory requires the rate-payer to pay a 
 rate adequate not only for a return upon the capital furnished by the 
 investor or stockholder, but adequate also to furnishing capital and a 
 return upon the capital furnished; it would authorize the capitalization 
 of excessive rates and a return upon that capitalization. This is to 
 put a premium upon extortions, past and prospective. On the other 
 hand, this theory is grossly unjust to prospective investors in that even 
 when the investment is made with entire honesty and with reasonable 
 prudence, yet if, pending the building up to the new business, the 
 plant depreciates below the fair cost to the investors, rates must 
 under this theory be made adequate to make return only upon the re- 
 production cost of the property in its depreciated condition. This 
 amounts to saying that money lost during the earlier stages of a publio 
 service enterprise is irretrievably lost by the stockholders; that if, per- 
 chance, rates have been fixed so low that the rate-payer has for a period 
 of years obtained a service at less than cost, this is the permanent mis- 
 fortune of the stockholders, and that the public should never, at any 
 time and under any circumstances, be called upon to make up a deficit 
 thus incurred. On this theory copper put into the telephone service at 
 25 cts. a pound is now to be reckoned as worth about half that sum. 
 Every fluctuation in prices involves the ascertainment of a new rate 
 basis. This theory is as inexpedient as it is unjust."^ 
 
 1 Decision of the Massachusetts Public Service Commission, ApprovinR an InoronBO in 
 the Rates of Fare of the Middlesex and Boston Street Railway Company, Oct. 28, 1914.
 
 108 VALUE FOR RATE-MAKING 
 
 Admitting that regulation has existed in the State of Massa- 
 chusetts for a number of years, it can hardly be claimed that 
 even the Massachusetts Commission has heretofore been assur- 
 ing investors that they were to get their investment back or 
 that early losses would later be made good. Certainly such 
 assurances could not have been made to investors in States 
 that have never had utility regulation until within the last 
 few years, consequently the investors, presumably in Massachu- 
 setts and certainly in other States, have actually been making 
 their investments upon the basis of standing the losses or gain- 
 ing the profits, as the case might be. Warrant for such basis 
 of investment is found in the rulings so frequently made by the 
 Supreme Court, that the present value of the property at any 
 given time is the basis upon which rates must be determined at 
 that time. It may be well enough for the commissions to in- 
 augurate a policy and give more or less definite assurances as 
 to the safety of investments and the recouping of early losses, 
 but in so doing, the present fair value of the existing property 
 must be taken as the starting point, not original investment 
 plus early losses. Certainly such assurance on the part of the 
 public authorities would be eminently fair, usually legal, and 
 would undoubtedly result in the securing of capital at a lower 
 rate of return than under the conditions heretofore existing, 
 where the investor had to cover the loss or gain made in his 
 investment by the rate of return obtained. The Massachusetts 
 Commission is wrong in stating that "no theory could work 
 out grosser injustice" than the reproduction cost theory, 
 because that theory is of fundamental importance in ascertain- 
 ing present fair value, which value is the one that both the in- 
 vesting public and the rate-paying public have been accustomed 
 to consider the fair and proper value in determining rates. There 
 is no reason to imply that "investments honestly and prudently 
 made and wisely managed" may not be as fully and fairly pro- 
 tected by allowing a rate of return sufficiently high to cover the 
 occasional loss of investment as to permit only a lower rate of 
 return upon the original investment, regardless of its present 
 value, with a view to insuring each such investment. The 
 writer has no quarrel with the principle that honest investments 
 should henceforth be protected, that a uniformly fair return 
 thereon will be assured, that early losses will be made good, but 
 in establishing this new regime ex post facto rulings must not
 
 COST OF REPRODUCTION io<j 
 
 be attempted by the substitution of original invest niciit i<n- 
 present fair value, which the courts rule is the starting [joint for 
 consideration in determining the basis of rates. 
 
 In summation, it may be said that the cost of rcprotluction 
 method should usually be given the greatest of weight of any of 
 the elements to be considered in fixing the present value of utility 
 property, because: 
 
 The reproduction method is universally applicable. 
 
 The reproduction method gives the present-day value of the 
 property. 
 
 The reproduction method is an eminently feasil)Ie and prac- 
 ticable method of arriving at value. 
 
 The reproduction method has been approved by the highest 
 courts. 
 
 Reproduction New. — The reproduction theory, as originally 
 developed, consists of estimating the cost of reproducing the 
 existing property under present surrounding physical con- 
 ditions, with present-day prices of labor and material, although 
 widely fluctuating prices are usually averaged. Thus it will be 
 seen that the reproduction theory attempts to fix the value of 
 an entire property as it exists as a present going business, in- 
 cluding any unearned increment due to increase over original 
 cost of real estate, labor or material, as well as such reduction 
 in value as results from improvements and economies in con- 
 struction methods, decrement in real estate or structural cost. 
 For example, a utility may have originally spent a large amount 
 of money excavating a trench with hand drills and black powder 
 that to-day would be built with modern machinery and high 
 explosives, but in ascertaining the present-day value, the cost 
 of doing the work with modern methods would usually be ac- 
 cepted. On the other hand, present cost of labor would be ap- 
 preciably higher than labor for any period a few years previous, 
 and so for most localities the present value of real estate would 
 be considerably higher than its value a few years ago. The ap- 
 plication of this method of utility valuation is merely applying 
 to such corporations the same economic rule that is generally 
 applied to private enterprises in fixing their values. 
 
 A modification of the above-described, strict reproduction 
 method has been developed in the attempt to keep down the 
 present values of existing utility property. This modification of 
 the pure reproduction method consists in estimating the cost of
 
 no VALUE FOR RATE-MAKING 
 
 reproducing the existing property on the basis of current prices 
 for labor and material, but differs by the substitution of original 
 surrounding conditions of land and structures at the time of 
 initial construction, in place of those actually existing at the 
 time of the valuation. Thus, the utility gains by any increment 
 in labor and material prices, but loses all enhancements of value 
 due to rise in prices of real estate, appreciation in roadbed, 
 adaptation and the like. The method may exclude or take ad- 
 vantage of modern methods of doing construction, as deter- 
 mined by the investigator. 
 
 A still further modification of the pure reproduction method 
 has been developed in reproducing the existing property not as 
 a whole, in a continvious process at one time, but rather in the 
 manner in which utility properties are usually constructed, that 
 is, by gradual extension or "piecemeal" or "retail" construc- 
 tion. This method, of necessity, results in a higher valuation 
 than the wholesale reproduction method, because small construc- 
 tion jobs cost more per given unit completed than large jobs, 
 and because continued accretions require tearing down, abandon- 
 ment or reconstruction of property that has been temporarily 
 completed. 
 
 Still another so-called, but inappropriately termed, reproduc- 
 tion method of determining value has been gaining favor re- 
 cently. The method may be identified and very much clarified 
 by coupKng with it the term "original cost." The "original- 
 cost reproduction" method consists of estimating the value of 
 the existing property on the basis of the prices paid for labor and 
 material at the time of the original construction of the existing 
 property; said construction being assumed to be done under 
 the original physical and surrounding conditions, at cost 
 usually determined from an examination of the corporation 
 books and records. As such method of valuation takes into 
 account only the property actually in existence, excluding all 
 that which may originally have been installed, but of which 
 there is no longer any use being made, it will be seen that this 
 method in no way corresponds to ascertaining the original 
 total investment, or total cost to date, referred to in preceding 
 pages. 
 
 The cost of reproduction new, as correctly interpreted for use 
 in rate-making, therefore means the estimated cost of construct- 
 ing anew the entire existing used and useful property, including
 
 COST OF REP HOD LOT ION HI 
 
 l)oth physical and non-physical parts. It further assunu's the 
 estimate is based upon: 
 
 First. — The use of such prices as are fair and average at tlie 
 time of the appraisal. 
 
 Second. — The application of modern methods and apparatus 
 with intelligent supervision and direction. 
 
 Third. — A reasonable and yet as brief a period for construc- 
 tion as is practicable to avoid inflating normal costs of lal)or, 
 material and financing. 
 
 To develop an estimate of the cost of reproduction, it is 
 customary to start with the physical property, then to add to 
 those costs first found what are loosely classified as "overhead 
 items," and afterward to include the cost of establishing the 
 business and other such non-physical elements. 
 
 The cost of reproduction new of the physical property in- 
 cludes the fundamental basic cost of land and the labor and ma- 
 terial costs of structures, including engineers' and architects' fees, 
 services of contractors w'here required, all kinds of insurance, 
 and the costs of administration, inspection, testing and other 
 similar expenses incurred during construction. To these basic 
 figures, which result simply in reproducing new the physical 
 property, there must be added certain non-physical or intangible 
 costs of two classes: 
 
 (a) Those incurred in connection with the preparation of the 
 physical property ready for service, including the cost of raising 
 the money, taxes and interest before and during construction, 
 expenses and services of the promoter, legal and engineering 
 advice preHminary to beginning construction, expenses of secur- 
 ing franchises, permits or other pubHc authorization, working 
 capital and similar matters. 
 
 (6) The cost of developing and attaching the business, that 
 is, securing a revenue. This includes interest or a fair return 
 on the value of the property, the necessary allowance to cover 
 deficits in operation and similar items that accrue until the 
 property is put upon a paymg basis. 
 
 The cost, preHminary to beginning construction of the physical 
 property, will ordinarily run from 5 per cent, to 15 per cent, of the 
 cost of the physical property. In the same way, the overhead 
 allowances to be added to the basic costs of the physical property 
 will amount to 12 to 25 per cent., depending upon general market 
 conditions, the size and risk of the enterprise. The cost of estab-
 
 112 VALUE FOR RATE-MAKING 
 
 lishing the business and obtaining a revenue sufficient to meet 
 operating expenses and a fair return upon tlie value of the 
 property varies with the character of the business and to some 
 extent with the size of the corporation and the type of the 
 community being supplied; it will vary from 10 per cent, to 50 
 per cent., but 20 per cent, of the cost of the physical property 
 is not an unusual figure. 
 
 SUMMARIZED ELEMENTS OF REPRODUCTION COST 
 
 1. Land: 
 
 (a) Real estate and water-rights. 
 
 (b) Rights-of-way, easements, etc. 
 
 2. Structural Costs: 
 
 (a) Physical property: construction and equipment. 
 
 (b) Contractor's services: including purchasing of materials and 
 equipment, assembling, conducting, superintending and executing 
 work. 
 
 (c) Engineering and supervision: including architect's fees, design- 
 ing, estimating, testing (on all construction and equipment items). 
 
 (d) Administration and management: including legal work on con- 
 struction, rent and upkeep of offices and storerooms, salaries, accounting, 
 city inspection, printing, stationery and other management costs on 
 construction. 
 
 (e) Omissions: incomplete inventories, buried, submerged, con- 
 cealed or inaccessible construction, loss and waste, incomplete unit 
 prices. 
 
 (/) Incidentals: items too small to inventory, watchmen, heating, 
 rent of land or construction buildings, duplicate or temporary work. 
 
 ig) Contingencies: corrections, disasters, delays, strikes, idle labor, 
 overtime, uninsurable losses, expressage on rush shipments. 
 
 (h) Insurance: fire, casualty, builder's risk. 
 
 (t) Development costs, such as unusual, abnormal or extraordinary 
 conditions: changes, reconstruction, obstructions, interferences, grad- 
 ing, extra cost of doing work while maintaining operation. 
 
 3. Overhead Costs: 
 
 (a) Interest during construction. 
 
 (b) Taxes during construction. 
 
 4. Cost Preliminary to Construction: 
 
 (a) Preliminary expenses: organization, administration, engineering, 
 legal, financial, 
 
 (6) Charter and franchise costs and fees: including permits, consents 
 and expenses of compliance with requirements.
 
 COST OF REPRODUCTION 113 
 
 (c) Promotion costs and services: reports, engineering, surveys, 
 interesting bankers, investors and local authorities. 
 
 (d) Financial costs: commissions to brokers and to underwriters, 
 cost of preparing and marketing securities. 
 
 5. Superseded Property Cost not yet Amortized. 
 
 6. Going Concern Cost: 
 
 (a) Cost of reproducing the earnings. 
 
 (b) Cost of creating, developing and attaching business, advertising, 
 soliciting, concessions, furnishing service or equipment free or below 
 cost, securing customers. 
 
 (c) Costs of deficits in earnings, operating losses from strikes, fuel, 
 shortages, etc., legitimate expenses to avoid uneconomic competition 
 and to increase net earnings per dollar of investment. 
 
 7. Additions under Way or Necessary to Provide Adequate Spare or 
 Reserve Plant or to Properly Handle Future Business. 
 
 8. Cash Working Capital : 
 
 (a) Cash: bank deposits and cash on hand. 
 (6) Credit balances. 
 
 (c) Investments: (if necessary and not fully self-carrying). 
 
 (d) Reserves: insurance, pension, etc. 
 
 (e) Deposits: (if required as surety by city, etc.). 
 
 Construction Schedule. — In order to make an estimate of the 
 cost of reproduction, it is necessary to formulate a rational 
 program upon which it may be assumed that a given property 
 may be built up along the lines of a definite and practicable 
 schedule. The property to be reproduced is considered as non- 
 existent, and all steps necessary to produce the existing property 
 must be assumed to be gone through with in order to obtain the 
 same results as exist in the actual property under consideration. 
 The argument that an estimate of the cost of reproduction is 
 based on an instantaneous recreation is illogical and misleading. 
 Such conception originated in the minds of theorists rather tliaii 
 practical constructionists. 
 
 Inventory. — In determining the value of property, unless 
 book values are accepted, an inventory of the structural parts is 
 first necessary. As the inventory will be the basis of the entu-e 
 valuation, it must be completed with much detail and great 
 care in order to secure reUable results. Within the limits of 
 the time usually allowable, and having regard for the expense of 
 the work and the liability of error on the part of the ordinary 
 employee, it is practically impossible to make a complete m-
 
 114 VALUE FOR RATE-MAKING 
 
 ventory of existing property. Experience shows, that even 
 with the most thorough work and constant checking, the quan- 
 tities hsted will be less than the actual amounts existing. 
 
 For purposes of verification and in order to comply with 
 court requirements, it is necessary to make a detailed inventory, 
 set up in exhaustive tabulations, of the property being appraised. 
 This is essential, although the labor and cost involved may seem 
 excessive and unwarranted, but is demanded as the one tangi})le 
 element to which all other elements or estimates of the appraisal 
 are definitely tied. The inventory, when priced, should, on 
 its face, clearly indicate the methods, quantities, unit prices, 
 with each overhead percentage, consecutively leading up to 
 sub-totals and finally the grand total of the completed appraisal. 
 
 In the making of an appraisal, nothing is more important 
 than a carefully prepared, accurate, complete, and reliable in- 
 ventory. For suggestions as to the lines to be followed for 
 convenient pricing, the proper division and classification of the 
 inventory, and other general discussions of the subject, the 
 reader is referred to Chapter IV of the author's "Valuation of 
 Public Utility Properties." 
 
 Unit Prices. — For the completion of the appraisal, the unit 
 prices to be used must be carefully determined. These prices 
 can usually be fixed without much difficult}^, if the basis of 
 the prices is clearly understood and held constantly in mind. 
 The weight of the best opinion at present holds that the cost 
 of reproduction is based on present prices, consequently while 
 it is necessary to examine bills, vouchers, contracts, minute 
 books, and other records of the corporation to obtain information 
 as to type and class of property under construction, and the 
 knowledge of actual costs in the past, such costs must be recast 
 after an investigation of present local conditions, and a con- 
 sideration of present-day quotations and costs, in order to fix 
 present fair prices. As unit prices are based upon facts, there 
 should be no difficulty in determining proper unit prices for 
 any particular case, where the necessary amount of detailed 
 labor is performed in collecting the information necessary upon 
 which to base conclusions. There is, however, apt to develop 
 a greater difference in the final values of property as determined 
 by different engineers, due to their use of different percentage 
 allowances required to cover the omissions, incidentals and 
 contingencies and other additions hereinafter discussed. These
 
 COtiT OF RKP HO DUCT ION 115 
 
 differences arise from the varyiiifr knowledge and experience of 
 the individuals determining the percentages applied, and such 
 differences may always be expected, although not thereby pre- 
 judicing or discrediting the results, except in so far as the stand- 
 ing or experience of the party fixing such percentages may be 
 prejudiced or discredited. 
 
 The making up of unit prices in any specific case will depend 
 upon: 
 
 (a) The local conditions, as for example, character of soil 
 in which the excavation is to be made, accessibility for the 
 delivery of parts shipped in, conditions of the available labor 
 market both as to quality and supply, and similar local 
 characteristics. 
 
 (6) The source and character of the information on which 
 the figures making up the unit prices are based. The informa- 
 tion will vary from mere hearsay to exact figures obtained for 
 similar work under similar conditions, and the dependence to 
 be placed on the source of information must be duly considered 
 and weighed. 
 
 (c) The refinement to be used in making up unit prices. 
 In some cases an average figure, based on proper experience and 
 judgment, may prove as satisfactory as a figure laboriously 
 worked out from a mass of varying data. There is always 
 opportunity for abbreviating the work by due consideration of 
 this matter by a competent expert. 
 
 (d) The relation of the unit price to the percentages to be 
 added later. 
 
 (e) Whether or not depreciation is to be allowed in the unit 
 price (not usually done). 
 
 (/) Whether the unit price applies to the raw material or the 
 finished product. For example, the purchase of a given number 
 of yards of sand, concrete and stone results in the production 
 of a yardage of concrete quite different from the sum of the 
 yards of the three constituents. 
 
 {g) Whether the unit price includes the cost of the labor, 
 material, supervision, administration expense, and incidentals 
 or whether these items are to be kept separate. 
 
 In order to obtain a total fair value of property, it is of cour.sc 
 essential to apply fair unit prices to the elements contained 
 in the completed inventory. Two unit prices, both fair, and 
 yet quite different in value, might be used; one, the higher.
 
 116 VALUE FOR RATE-MAKING 
 
 would include certain allowances which the other would not 
 include, because added later as a percentage of the total net 
 cost. As will be seen, the first method endeavors to fix the 
 total cost, to the corporation, of the item being considered, 
 completely installed, including all allowances, but the second 
 method, one which is now much in vogue, endeavors to ascertain 
 the exact price for each item bought separately, then to add to 
 the net valuation, obtained by applying such unit prices to the 
 inventory, definite percentages to cover first, an allowance that 
 would have to be paid a general contractor for doing the work of 
 assembling and unifying the elemental parts, and second, an 
 allowance to cover engineering, administration expenses, con- 
 tingencies and omissions, etc. 
 
 Fluctuating Prices. — While there is some difference of opinion 
 as to whether unit prices of items, which fluctuate widely in cost, 
 should be based precisely upon those current at the time of the 
 appraisal, or whether averaged prices, extending over a period 
 of years should be used, the more generally accepted method is 
 to equalize the fluctuations on the ground that a constant rather 
 than a momentary valuation of utility property is desired. 
 In some instances, the varying prices within a period previous 
 to the date of the appraisal, have been averaged and adopted. 
 A common and customary practice is to assume a period of five 
 years, obtaining the average price of labor and materials during 
 such period. Where there is a tendency toward higher or 
 lower prices, such tendencies are sometimes considered, when 
 the cost at the time of the inquiry may be adopted as more nearly 
 representing fair average conditions. As the purpose of valua- 
 tion is to ascertain fair present value, fairness must be applied in 
 determining current prices. The price of real estate may have 
 been rising rapidly for a period of years, and the use of an 
 average figure for the preceding five years would be manifestly 
 unfair. In the same way, the uniform tendency of the cost of 
 lumber to rise, makes the present price fairer to the recently 
 constructed utility than the average price. In the same way, 
 the uniformly decreasing cost of steam turbines or certain 
 electrical apparatus might make the use of the average price 
 in place of the present price unfair to the public, so that the 
 adoption of average prices based on the average of fluctuating 
 prices over a period of years, must be used with caution and 
 discretion.
 
 COST OF REPRODUCTION m 
 
 Contractor's Profit. — Where unit prices have been made up 
 upon the basis of raw materials or apparatus simply delivered at 
 their destination, and labor has been put in upon the basis of 
 wages paid workmen, it is quite customary to add a certain per- 
 centage to cover the charges for a contractor's services and ex- 
 penses. It is, of course, impossible to use labor in putting 
 raw materials together without necessary supervision, which is 
 charged for under the term "contractor's profit." Sometimes 
 this percentage is added to the cost after applying unit prices 
 to the inventory, but quite often the allowance for contractor's 
 profit is added to the unit price itself before application to the 
 inventory, so that no such percentage or allowance is apparent 
 in the final valuation tabulation. This difference of procedure 
 has caused a large amount of misunderstanding and con- 
 troversy as to what is fair and customary, or what allowances 
 have been made by engineers or public authorities in fixing values 
 of property. It may be said that practically without exception, 
 an allowance to cover the contractor's expenses and services 
 has been included even in what is shown as the "bare bones" 
 cost of the structural property, in all valuations of impartial, 
 intelligent public authorities that set up no separate allowances 
 for "contractor's profits," unless the work is assumed to be done 
 by Company forces and a different unit price adopted. The 
 allowance for the contractor will vary from 5 per cent, to 15 or 
 20 per cent, upon the cost of labor and materials furnished under 
 his supervision. In some instances the percentage on labor 
 will be different from that on material, for example, 10 per cent, 
 on material and 15 per cent, on labor has been a common allow- 
 ance where contractors are working on a "time and material 
 basis," that is, where the owner assumes the risk, and the 
 contractor furnishes simply his services and his own incidental 
 costs. Where the contractor assumes the risk of completing the 
 entire work, in large undertakings he will often figure from 
 20 to 50 per cent, additional to the costs to him of completing 
 the property, the percentage varying by reason of the liability 
 to accident, definiteness of contract, keenness of competition, 
 and other local conditions. 
 
 Engineering, Architects' Fees, etc.— It is quite customary, and 
 usually proper and necessary for engineers, architects, or other 
 qualified experts, to be employed to supervise and design the 
 construction of any large property. The charge for such services
 
 118 VALUE FOR RATE-MAKING 
 
 is ordinarily based on the cost of the work supervised; con- 
 sequently it has become an accepted rule in valuation work, 
 to add a general percentage to the "general contractor's cost," 
 or the base cost "of the physical property," to cover the services 
 and expenses of the engineer or architect. Sometimes, as is 
 done by the Wisconsin Commission, a single percentage covering 
 engineering, contingencies, omissions, and other less important 
 items is added, but this is usually not as satisfactory or as 
 accurate as determining the proper percentage for each of these 
 elements of cost, and allowing therefor separately. The reason 
 for this is that the percentages are applicable to and vary with 
 the different elements of property, and an attempt to apply a 
 single percentage results in confusion and controversy. For 
 example, the same percentage applied to the unit cost of real 
 estate, with the purchase of which an engineer or architect usu- 
 ally has little to do, makes it appear as if a percentage was being 
 unfairly allowed and added, necessitating an explanation. 
 However, a proper, averaged percentage can usually be sustained 
 on the ground that while inapplicable to certain items, because 
 too high, yet it is too low for other items, and hence its general 
 application to all items results in adding only the proper amount 
 in fixing the value of the whole property. The usual engineer's 
 and architect's fees vary from 5 per cent, to 10 per cent., in some 
 instances running even higher. Five per cent, has been quite 
 generally accepted as the proper engineering cost, based on 
 actual charges made by engineers, and upon records of similar 
 costs where kept accurately and fully. 
 
 Omissions, Incidentals, and Contingencies. — In order to 
 compensate for these several items, it is considered proper, and 
 has become generally customary to add a small percentage, from 
 1 to 10 per cent., to the sub-totals in the inventory, after adding 
 unit prices. Considering the allowances made separately for 
 each class, that for omissions is usually from 2 per cent, to 5 per 
 cent., varying with the thoroughness with which the work has 
 been carried out. Aside from omissions, there are always a 
 large number of small items which cannot be included separately 
 in inventory, on account of the labor and expense involved in 
 exactly ascertaining what they are, and listing them. These 
 small items are usually called incidentals, and like omissions, 
 are allowed for by adding a small percentage, depending on the 
 minuteness of the inventory, to cover such items. The per-
 
 CO^T OF REPUODVCTIOX m, 
 
 centage allowed for incidentals will vary from 3^-^ per cent, to 
 5 or 6 per cent., and is usually taken at from 3 to 5 per cent. 
 In addition to omissions and incidentals, the item of conlin- 
 gencies must be taken into account in the inventory. Con- 
 tingencies are determined from a consideration of the particular 
 property, and type of construction under consideration. Actual 
 quantities measured in place always overrun the theoretical 
 quantities required, due to loss, wastage, shrinkage, calamities, 
 ordinary human liability to error, and the impossibility of con- 
 structing property with geometrical exactness. In the con- 
 struction of practically all physical properties, the elements must 
 be taken into account, and the losses they cause recognized and 
 allowed in the valuation. In building a dam, floods are almost 
 certain to wash away material, and even parts of completed 
 construction; the actual weight of cast-iron pipe and metal work 
 must run in excess of the specifications in order to avoid pen- 
 alties. Earth work compacted in place is much less than the 
 yardage of loose material moved; necessities of construction 
 work require temporary structures, or the taking down and re- 
 building of certain parts. The allowances for contingencies may 
 be covered in part by a knowledge of the history of the property 
 being considered, including records as to conditions and costs of 
 construction. Where such knowledge is not obtainable, experi- 
 ence in similar work must be the guide, but in every case the 
 contingencies should be covered by a percentage allowance added 
 to the value of the inventoried property, varying from 3 per cent, 
 to much larger amounts, depending on the class of propertj- and 
 the knowledge of the liability for contingency under the necessary 
 conditions of construction. 
 
 Insurance. — The recent and general agitation for the protection 
 of both the public and employees against accidents, together with 
 the many ''compensation laws" being passed by state legislatures, 
 have resulted in making the item of insurance a very appreciable 
 one, in comparison with the various other expenditures incurred 
 in completing a public utility property. In many early appraisals 
 the cost of insurance was so small as generally to be included with 
 other incidentals in a common percentage, but the man}'- classes of 
 insurance now required, namely, that against injury to the pul)lic 
 and employees, damage from fire, flood and tornadoes, guarantees 
 for the protection of property against accident, against failure to 
 complete on time, and similar matters, have compelled recognition
 
 120 VALUE FOR RATE-MAKING 
 
 of a separate allowance to cover specifically insurance of all kinds. 
 The amount to be allowed for insurance will depend upon the 
 location and character of the construction work undertaken. 
 The risk of injury to individuals is, for example, much greater in 
 the construction of an underground electric trolley road in the 
 streets of New York City than in construction of steam railroads 
 across the open country, and the insurance rate will correspond- 
 ingly differ. The liability to damage from fire is, of course, much 
 greater in a building constructed of wood than one of concrete 
 and steel. In some places tornadoes are unknown, while in other 
 sections of the country they are relatively common occurrences; 
 on some streams sudden and heavy floods are to be expected, on 
 other streams they are unusual, so that the proper amount to 
 allow for insurance in the construction of any given property is 
 determined from a consideration of local conditions and the risks 
 involved. Expressed in a percentage, the expenditures for insur- 
 ance, reasonably necessary in the construction of utility property, 
 will seldom be found to be less than one-half of 1 per cent, of the 
 cost of the physical property, and under extreme conditions may 
 amount to as much as 4 or 5 per cent. 
 
 Development Costs. — With regard to property constructed 
 under conditions other than those which now exist, it may be 
 necessary to include under "development costs" the expense 
 incurred in creating existing conditions. For example, in the 
 construction of the underground trolley roads in New York 
 City, it was necessary to remove from the center to the side 
 of the street gas pipes, water mains, and other obstructions, so 
 that, at present, the rights-of-way on which the tracks are laid 
 are free and clear. The cost of reproducing the existing property, 
 without taking into account the former obstructions in the 
 cleared rights-of-way, would not adequately represent the value 
 of the existing property, and, therefore, the cost of clearing the 
 obstructions must be included as a "development cost." Simi- 
 larly, street grades may have been changed, fillings made, 
 temporary constructions installed, such as coffer-dams, work 
 buildings and the like, or unusual conditions may exist which, 
 not apparent on first sight, nevertheless require consideration, 
 and proper recognition. 
 
 Interest. — The interest charges accumulating on capital ex- 
 pended during the construction of utility property properly 
 becomes a part of the capital investment. This principle is
 
 COST OF REPRODUCTION 121 
 
 practically universally conceded both by public service coni- 
 missions and the courts: 
 
 "No case has been cited, and in our investigation wc have found 
 no case involving this question, where a reasonable amount has not 
 been considered and allowed for loss of interest during construction, as 
 a part of the cost of construction."^ 
 
 Opinions differ as to the proper annual rate of interest to be 
 allowed but this will, of course, vary, due to local conditions and 
 the difference in the normal rate of interest prevailing in different 
 sections of the country. The usual procedure is to allow the 
 full interest rate, for half the construction period, on the total 
 cost of the property, or, what amounts to the same thing, half 
 the interest rate, for the entire period of construction. 
 
 It has been claimed, with justification, that the rate of interest 
 allowed should be the same as the rate of return allowed, on the 
 ground that the investors should not be limited merely to the 
 legal rate of interest during the construction period any more 
 than during the remainder of the life of their property. Another 
 important consideration in determining the allowance for interest, 
 is whether it may be assumed that cash will be advanced l)y the 
 stockholders or bankers, as representative of the bondholders, in 
 such amounts as may be required from month to month to meet 
 construction accounts falling due, or whether practically the 
 whole amount of money required for construction will be paid in, 
 at or about the time construction begins. In the case of proper- 
 ties costing relatively small amounts, say less than $500,000, it is 
 seldom that any particular advantage can be obtained by attempt- 
 ing to distribute the payments of capital in accordance with con- 
 struction requirements, and even in the case of very much larger 
 properties the same still holds true. This is well illustrated by 
 what has taken place recently, in New York City, in connection 
 with the securing of money by the Brooklyn Rapid Transit Com- 
 pany for the construction of subways. It became necessary for 
 this company to borrow $40,000,000 with which to carry out its 
 constructions. It did not expect to be able to expend more than 
 about $17,000,000 in anyone year; nevertheless, on Oct. 1, 1912, it 
 obtained the whole $40,000,000, having to pay therefor interest 
 at the rate of 6 per cent. It placed this money in the bank, ob- 
 taining therefor 3 per cent, interest, and claimed the right to 
 
 1 Pioneer Telephone & Telegraph Co. vs. Westenhaver, 118 Pac. 354.
 
 122 VALUE FOR RATE-MAKING 
 
 charge the difference, 3 per cent, on $40,000,000, as part of the 
 cost of plant construction. One of the Directors of the Transit 
 Company, in a reported interview, explained the matter as 
 follows : 
 
 " He pointed out that the B. R.T. had acted according to good business 
 policy in borrowing $40,000,000 on Oct. 1, last. He said that the only 
 way that the company would be sure of having the money when it needed 
 it, even if the need should come several years hence, was to borrow it 
 then altogether when the rates were easy. If it were to go into the 
 money market now it would have a much harder time of it, he said."^ 
 
 Taxes. — Taxes that accrue during construction of utility prop- 
 erty, like interest, are considered a part of the capital invest- 
 ment. They are sometimes allowed as a percentage, charged 
 the same as interest, but a fairer and more exact method is to 
 base the allowance upon estimates made up from a consideration 
 of the taxes actually being paid, itemizing real estate taxes from 
 Federal or revenue and other taxes. The Public Service Com- 
 mission of New York, First District, in its instructions contained 
 in its "uniform system of accounts for electrical corporations" 
 provides, on page 18, item E284, the following: 
 
 "Charge to this account all taxes and assessments levied and paid on 
 property belonging to the corporation while under construction and be- 
 fore the plant is opened for commercial operation, except special taxes 
 assessed for street and other improvements, such as grading, sewering, 
 curbing, guttering, paving, sidewalks, etc., which shall be charged to the 
 account to which the property benefited is charged." 
 
 Preliminary Expenses. — Closely related to the work of the 
 promoter are the expenses incurred in the creation, organization 
 and starting of a utility corporation. In addition to the legal 
 work involved in obtaining, perfecting and approving franchises 
 or consents of public authorities engineering estimates must be 
 checked and approved, financial prospects of revenues and earn- 
 ings recast and certified, arrangements for financing completed, 
 the formation of a working organization instituted and general 
 plans completed for carrying out the construction and operation 
 of the property for which the corporation has been originated. 
 
 Preliminary expenses will vary with the type and character 
 of the utility being considered, and under normal conditions 
 these expenses will amount to from 1^^ to as high as 10 or 15 
 
 i New York Sun, Dec. 14, 1912.
 
 COST OF REPRODUCTION 123 
 
 per cent, of the cost of those physical properties which event- 
 ually prove successes. Of course, money expended for prelimi- 
 nary work is entirely lost in those corporations which nvxi'x 
 complete their physical properties, or if completed prove to he 
 financial failures. 
 
 Promotion. — The services and expenses of those engaged in 
 originating and getting a utility property "on its feet" are 
 generally recognized and allowed as a part of the capital cost. 
 The report of the Railroad Securities Commission, consisting of 
 Arthur T. Hadley, Frederick N. Judson, Frederick Strauss, 
 Walter L. Fisher and B. H. Meyer, to President Taft, at page 30, 
 under the head of "Promoter's Profits and Services," says: 
 
 "We are told that the profit of the promoter represents a wholly un- 
 necessary burden upon the American pubhc, and that so far a.s this 
 profit can be done away with it will be good for all parties. Neither of 
 these statements is quite true. The promoters, using the term in a 
 broad sense, may be divided into two classes: constructors who build a 
 road whose future is uncertain, in the expectation of selling the stock for 
 more than it costs them; and financiers who induce the public to buy 
 the bonds of such roads. Both of these classes, if they do their work 
 honestly, render useful services to the public. The constructor gives our 
 undeveloped districts the benefit of new roads, which they would not get 
 without his intervention; and if he does his business well he builds the 
 road more economically than anybody else could. The financier renders 
 an equally important service in collecting the capital of the investors to 
 build new railroads or improve old ones." 
 
 The public service commissions have very generally recognized 
 the value of the services of the promoter, although some hold that 
 his reward should be given by allowing a larger rate of return 
 rather than by a lump sum included in the capital account. The 
 courts have also recognized the legitimacy of the promoter's 
 services; in one case referring to such services in effecting the 
 consoHdation of numerous independent railroad properties into 
 what is now known as the Southern Railroad System, the Court 
 said : 
 
 "This enterprise is a perfectly legitimate one. The men who have 
 received and executed it are entitled to a fair return upon the money 
 which has been actually invested in it. They are entitled, in addition, 
 to a reasonable profit upon the ability to conceive and execute a project 
 of this sort."i 
 
 ' City of Danville el al. vs. Southern Ry. Co., 8 I. C. C. U. 409. 438.
 
 124 VALUE FOR RATE-MAKING 
 
 In contracts between municipalities and utility corporations, 
 paj^ment for the promoter's services, either in constructing the 
 property or procuring funds, has frequently been recognized. 
 In the existing contracts between the City of Chicago and the 
 Traction Companies there is a clause which recites that 5 per 
 cent, "shall be paid for the Company's services in procuring funds 
 therefor, including brokerage." 
 
 The English courts have recognized the necessity for remuner- 
 ating the promoter, saying: 
 
 "In other words, we must either refuse to follow the formula approved 
 by the House of Lords and agreed to by the parties, or find, as a fact, 
 that money can be procured for nothing."^ 
 
 The public service commissions have, in some instances, used 
 5 per cent, to cover the expenses and services of the promoter. 
 In the case of the Central California Gas Co., the Railroad Com- 
 mission of California allowed $12,000, being: 
 
 "$1,000 per month for the 12 months during the organization period. "^ 
 
 A more recent decision by the same Commission, Decision No. 
 1075, decided Nov. 11, 1913, in the case of the San Rafael & 
 San Anselmo Valley Railway Co., page 6, approves $2,500 in 
 stock, $1,700 in bonds and $5,000 in cash, in all $9,200, to the 
 promoter of a projected railway applying for issuance of stock 
 and bonds aggregating $97,379.92, revised estimate of cost of the 
 project. This would be allowing in bonds and cash $6,700, or 
 7 per cent, of the total cost of the project. If we consider the 
 stock as worth 50 cts. on the dollar, the total allowance for 
 promoter's services would be $7,950, and this is 8 per cent, of 
 $97,379. Figuring stock at par the fee amounts to nearly 10 per 
 cent. 
 
 Financial Costs. — In order to raise money for any corporation, 
 either through the sale of stock or bonds, more or less expense is 
 necessarily incurred. From the standpoint of public utility 
 regulation it is immaterial from what source the money may come 
 which is invested in property used for serving the public. The 
 fair return allowed is based upon the value of the property. If 
 the money necessary to create this value may be raised entirely 
 
 ' National Telephone Company, Limited, vs. H. M. Postmaster, General Decision by 
 Judge Lawrence, 1913. 
 
 ^Volume 2, page 116, California Decisions.
 
 COST OF REPRODUCTION 125 
 
 through the sale of stock which in that case will require certain 
 outlay in order to dispose of the stock, or the money may be raised 
 partly through the sale of stock and partly through the sale of 
 bonds, in which latter case some of the expense of marketing stock 
 will be saved as compared with the condition of raising all money 
 through the sale of stock, but on the other hand new expenses an; 
 incurred in disposing of bonds. This latter expense is usually 
 brokerage and is paid to bond houses for their services and ex- 
 penses in marketing bonds. In either case these financial ex- 
 penses are a legitimate part of the cost of creating the property 
 just as much as the charges for legal or engineering services, or 
 the purchase of physical plant. Naturally the cost of financing 
 will vary with the character and reputation of the utility being 
 considered, but will rarely be found to be less than 2>^ per cent., 
 and may amount to 10 or 15 per cent, of the face value of the 
 securities sold. 
 
 Overhead Charges. — The term "overhead charges" is fre- 
 quently used in a loose way to indicate all allowances of an in- 
 tangible nature added to the purely physical costs in estimating 
 the total appraisal. Such use of the term may, but more usually 
 does not, include the allowance for the contractor's or sub- 
 contractor's services and expenses. In its broadest use it does 
 include engineering, omissions, incidentals, contingencies, in- 
 surance, interest and taxes during construction, costs of financing, 
 administration expenses preliminary to and during construction, 
 as well as for promoter's charges, if allowed. Although not 
 usually so, overhead charges are sometimes taken to include 
 going value and franchise value. 
 
 The allowance of 12 or 15 per cent, to cover overhead charges, 
 made by the Railroad Commission of Wisconsin, has been made 
 the basis of a similar percentage allowance by other commissions 
 without appreciation of the basis on which unit costs are made up 
 by the Wisconsin Commission. Where unit prices do not include 
 anything for contractor's profit, insurance, administration ex- 
 penses during construction, contingencies, incidentals and other 
 such items, the addition of 12 or 15 per cent, is not usually suffi- 
 cient to cover all proper overhead charges. That this is the con- 
 clusion of the Wisconsin Commission itself is shown by such 
 statements as the following, made in connection with the testi- 
 mony of two contractors who testified as to the necessity for larger 
 overhead allowances than those made by the Commission:
 
 126 VALUE FOR RATE-MAKING 
 
 "While their testimony throws some light on the situation, their 
 figures apply to the overhead charges of their own contracts, rather than 
 to the allowance which should be added to the estimates of the Commis- 
 sion's engineers. Both of these contractors have installed equipment for 
 the respondent company and the figures used by the staff include in the 
 unit price the overhead referred to; for example, the price used for a 
 holder is the price of the unit in place. This price covers design, mate- 
 rial, shop and installation labor, freight, various overhead charges, and 
 profit. The overhead here included is the overhead to which the wit- 
 nesses referred and is different from the additional percentage which 
 must be added to the cost of this holder to cover the indirect expense 
 which the purchaser must incur. What has been said in regard to holders 
 applies, to a large extent at least, to retort house equipment, condensing 
 and purifying apparatus, water-gas machinery, coal-handling apparatus, 
 etc. ; in fact, to all equipment which is customarily furnished erected in 
 place by the manufacturer or contractor. In all such cases, the prices 
 used by the staff are intended to cover the reasonable value of this equip- 
 ment as erected. The testimony of these witnesses, however, shows that 
 a good deal of the engineering is done by the contractor and that on a 
 considerable portion of the property under consideration the contractor 
 assumes the risks of installation. This would tend to decrease the allow- 
 ance necessary for use of tools, contingencies, insurance and damages, 
 omissions, etc."^ 
 
 From the preceding it will be recognized that where the Rail- 
 road Commission of Wisconsin takes "the price of the unit in 
 place," which price necessarily includes all the overhead charges 
 added by the contractor to his cost of labor and material, and 
 adds to that contract price 12 or 15 per cent., the Wisconsin Com- 
 mission has thereby allowed somewhere between 20 and 50 per 
 cent, above the unit price that would be used, for example, by the 
 Public Service Commission of New York City, at least on the 
 basis of costs used by the latter during the time that the writer 
 was doing work for the Commission. This will explain why some 
 commissions, including New York, basing their unit prices more 
 nearly on labor and material costs, add larger percentages than 
 12 or 15 per cent, to cover the so-called overhead items of the 
 Wisconsin Commission. 
 
 The Public Service Commission of New York, First District, 
 in the Queens Borough Gas & Electric Company case, made al- 
 lowances, to show which the following table is here given: 
 
 • City of Milwaukee vs. Milwaukee Gaa Light Co., 12, W. R. C. R., page 445.
 
 COST OF REPRODUCTIOS 
 
 12 < 
 
 T.^BLE 11 
 
 
 
 Queens Borough case 
 
 Gas dept. 
 
 Electric dept. 
 
 Tof.l 
 
 Net cost of property other than land 
 C. P., eng., admin., cont., and inci- 
 dentals 
 
 $707,815 
 
 136,345 
 19.25 
 
 $637,724 
 
 126,608 
 19.85 
 
 $1,345,539 
 
 262,953 
 19 55 
 
 Per cent, allowed 
 
 
 
 It is distinctly stated in the opinion that the above valuation of 
 $1,345,539 contains sub-contractor's profits. It is seen that, 
 in addition to such sub-contractor's profits, there was allowed 
 in this case for general contractor's profits, engineering, adminis- 
 tration, contingencies and incidentals, $262,953. This is 19.5 
 per cent, of the net cost of the property, other than land. But, in 
 addition to this, there was allowed, besides $75,000 for working 
 capital, the sum of $220,000 for ''preliminary and development 
 expenses." This is 16.3 per cent, of the net cost of the property 
 other than land. Hence, there was allowed here for overhead 
 charges, including the contractor's services and expenses, 35.8 
 per cent, of the cost of all of the property, aside from land, before 
 it was depreciated, and this cost is in addition to the allowance 
 for sub-contractor's profits. Had the allowances been made upon 
 the depreciated property it would have amounted to 55 per cent. 
 of such property, over and above the sub-contractor's fee, as is 
 seen by subtracting from $1,345,539 the sum of $468,680, leaving 
 $876,859, and of this sum $482,953 is 55 per cent. These allow- 
 ances do not include any allowance for going value. 
 
 In another similar case of the Brooklyn Borough Gas Company, 
 the Commission allowed $202,201, that is, 24.1 per cent, of the 
 net cost of the property other than land, "for general engineering 
 supervision, administration expenses, contingencies, incidentals 
 and general contractor's profit," in addition to $180,000, or 
 21.5 percent., for preliminary and development cost. The sum of 
 these two percentages is 45.6 per cent, added to the cost of the 
 property new, aside from land, for overheads. 
 
 In another case, in Kings County Lighting Company, where the 
 cost new of the property, outside of land, was placed at $1 ,56 1 ,628, 
 $260,000 or 16.7 per cent, was allowed for " preliminary and devel- 
 opment expenses," and $341,149 or 20.8 per cent, for contractor's 
 profit, engineering, etc., a total of 35.7 per cent, for overheads. 
 These figures are shown in detail in the following table:
 
 128 
 
 VALUE FOR RATE-MAKING 
 
 T.\HLK III. — Comparison of Ovkrheads Allowed by New York 
 CoM.MissioN, First District 
 
 (Queens Borough 
 (;ii.< & F.lec C-(). 
 
 King.* County Brooklyn 
 Lighting Co. Borough Gas Co. 
 
 Net cost of property other 
 
 $1,345,539 = 100.0% 
 
 262,953= 19.5% 
 220,000 = 16.3% 
 
 $1,561,028 = 100.0% 
 
 341,149 = 21.8% 
 260,000 = 16.7% 
 
 $838,154 =100.0% 
 202,201 - 24 1 % 
 
 Contractor's profit, engi- 
 neering, administration, 
 contingencies and inci- 
 
 Preliniinary and develop- 
 ment 
 
 180,000 = 21.5% 
 
 (A) Total 
 
 Working capital 
 
 $482,953 = 35.8% 
 75,000 = 5.6% 
 
 $601,149 = 38.5% 
 80,000= 5.1% 
 
 $382,201 = 45.6% 
 40,000= 4.8% 
 
 
 (B) Total 
 
 $557,953 = 41.4% 
 
 $681,149 = 43.6% 
 
 $422,201 = 50.4% 
 
 A recent decision has been rendered by the New York Pubhc 
 Service Commission, First District, in re Bronx Gas & Electric 
 Company, which exhaustively reviews the overhead allowances 
 previously made by the Commission, and in fixing the value of 
 the property of the company named, allows in said valuation 2 
 per cent, of the value of the physical property for incomplete 
 inventory, 20 per cent, on the sum of the two preceding amounts, 
 for engineering, supervising, contractor's profit, contingencies 
 and incidentals, plus 12 per cent, for preliminary and develop- 
 ment expenses. The detailed figures of the appraisal are as 
 follows : 
 
 Bronx Gas & Electric Company 
 
 Total gas and electric net reproduction cost Per cent. 
 
 (exclusive of real estate) $785,508 .44 = 100 . 
 
 Incomplete inventory 15,710.17 = 2.0 
 
 Additions for other overheads 160,243.71 = 20. 4 
 
 Preliminary and development expenses ... . 107,020.68'= 13.6 
 
 Total overheads $282,974.56 =36.0 
 
 Working capital (excess of current assets 
 
 over liabilities) 45,032.41 = 5.7 
 
 One of the most important and widely discussed decisions of any 
 public utility com mission is that rendered by the Board of Utility 
 Commissioners of New Jersey in the Passaic gas rate case. The 
 sul)ject of overhead costs and going value was thoroughly con- 
 sidered and fully disclosed, and the allowances therefor have 
 
 ' Based on an allowance of 12 per cent, upon the depreciated value of the physical property 
 plus the appraised value of the real estate.
 
 COST OF REPRODCCTTOX 120 
 
 been considered and approved by the Supreme Court and tlic 
 Court of Errors and Appeals of New Jersey. On the following 
 page is given a table summarizing the detail of findings an<l 
 allowances made by the Commission. From this talkie it will be 
 seen that the allowance made for all overheads, including going 
 value, was 51.45 per cent, of the net cost, to reproduce the plant 
 new, in addition to and on top of the allowances made for reward 
 to the contractor, covered in the unit values adopted for the phy.s- 
 ical property, before the 51.45 per cent, was added. 
 
 Table IV. — General Summary of Commission Findings 
 Passaic, N. J. — Public Service Gas Company. Board of Puljlic Utility 
 Commissioners, N. J. Order Fixing Rate — Decided December 26, 1912. 
 Land (at appraisal value plus 10 per cent, on 
 
 about 70 per cent, of total for "plottage" 
 
 or "assembly" value, i.e., 7 per cent, on 
 
 land total) $ 111,160.00 
 
 Organization; franchises; patent rights; other 
 
 intangible gas capital; cost of establishing 
 
 business; law expenses during construction. 1,025,000.00 
 Manufacturing plant X 1.176 
 
 (plus 17.6 per cent.) = $1,161,550 
 
 Distribution system X 1.176. . . = 2,4 65,270 
 
 $3,626,820 
 Less 3 months' construction to 
 
 bring appraisal to 7/1/11 62,000 
 
 .$3,564,820 
 
 which is made up of 
 Net cost of structure $3,030,612.00 
 
 and 17.6 per cent, thereof for: 
 
 Per cent. 
 
 Engineering and supervision 5.0 
 
 Omissions 2.0 
 
 Contingencies 2.0 
 
 Organization, liability, taxes 2.0 
 
 ~iI7o 
 
 Interest at 6 percent, on 1.11 per cent. 6.6 
 
 17.6 534,208.00 
 
 Working capital 250, 000.00 
 
 Total-new .$4,950,980.00 
 
 Accrued depreciation deducted 200,980.00 
 
 "Present Value" $4,750,000.00 
 
 1,025,000+534,2 08 ^ 1,559,2J)8 ^ ^^^^ ^^^ ^^^, ,„ ,,. 
 3,030,612 3,030,612 '^'- ' 
 produce new. 
 
 (This 51.45 per cent., total overhead is exclusive of 87.500 alrwuiy included for land 
 "plottage.") 
 9
 
 130 VALUE FOR RATE-MAKING 
 
 Superseded Plant. — Probably, on a strictly reproduction basis, 
 superseded plant should not be included in the present value of 
 existing property; certainly not, provided accurate estimates of 
 the rate of depreciation had been made and allowances for the 
 accumulation of necessary depreciation reserves had been pro- 
 vided in the rate of return allowed. As a matter of fact, esti- 
 mates as to the rate of depreciation in the future are at best 
 merely intelligent guesses based on the widest information and 
 experience available. Such estimates being forecasts of the 
 future are necessarily imperfect, so that even where earnings 
 might be sufficient to provide reserve funds, such funds may not 
 have been accumulated because of erroneous estimates as to the 
 rate of depreciation. In many instances earnings have not been 
 sufficient to provide depreciation reserves in large enough amounts 
 to take care of rapidly accruing depreciation, so that it has not 
 been possible to write off the superseded property. Under such 
 conditions courts and commissions have recognized the principle 
 that in fixing rates, allowances should be made in some form for 
 the loss sustained because of such superseded property. Some- 
 times this loss may be included in "going value, " particularly 
 where such item is estimated from a consideration of the cost of 
 building up the business. Where rates have not been sufficient 
 to pay all fair operating charges, a fair return upon the value of 
 the property and take care of depreciation, the value of super- 
 seded property may fairly be included in the amount used as the 
 basis in fixing the fair return. 
 
 The Municipal Commission of Milwaukee, Wis., in one im- 
 portant case, where it found the value of the local utility property 
 to amount to about $5,000,000 on the basis of reproduction cost, 
 excluding all value of superseded plant, the Court of Appeals 
 set aside the order of the Commission on the ground that at least 
 $2,000,000, or 40 per cent, additional, should have been included 
 as representing cost of plant which had disappeared from the 
 present inventory: 
 
 "I am satisfied that the property of complainant represents a value, 
 based solely upon the cost of reproduction, exceeding $5,000,000. 
 And I am further satisfied that this amount is not the true measure 
 of the value of the investment in the enterprise." ... "Of the 
 $5,000,000 and over paid for the acquisition of the old fines, it would be 
 difficult, if not impossible, from the testimony to arrive at any fair 
 approximation of the share or amount of tangible property which
 
 COST OF REPRODUCTION \:u 
 
 enters into the valuation in this inventory. It does appear that tlie 
 roadways require reconstruction with new rails and paving, and tliat 
 the amount stated was actually paid by the investors, making their 
 investment nearly $9,000,000. How much of this may be defined or 
 apportioned as the amount which was both 'really and necessarily 
 invested in the enterprise' {vide Road Co. v. Sandford, supra), I have 
 not attempted to ascertain, except to this extent: that I am clearly 
 of opinion that at least $2,000,000 of these preliminary expenditures 
 are entitled to equitable consideration, as so invested, beyond the re- 
 production value, if the valuation of the investment is not otherwise 
 found sufficient for all purposes of this case."^ 
 
 "It is not always reasonable to cast the entire burden of depreciation 
 on those who have invested their money in railroads. "^ 
 
 The principle enforced by the court on the commission, in the 
 above case is well illustrated in the appraisal of the Chicago 
 Consolidated Traction Company's property in 1910, where an 
 allowance was made for overhead charges of over 38 per cent, 
 and in addition to this they allowed several millions for franchise 
 value for an old cable road which was in disuse and which was 
 immediately pulled up and thrown away, and on top of those old 
 properties that were out of date, they capitalized the total cost 
 of the new property, so that in fact this Chicago property now 
 has perhaps 60 per cent, added to it. 
 
 The St. Louis Public Service Commission, in the case of the 
 Union Electric Light & Power Company, evidently included the 
 cost of a certain amount of "superseded property" in its allow- 
 ance for "established business," for, after referring to "going 
 value" as identical with the cost of "establishing the business," 
 the Commission adds: 
 
 "The Commission is endeavoring to arrive at a fair value of the 
 property at present in the service of the public and does not consider 
 that abandoned property enters into the calculation except so far as 
 it effects the cost of establishing the business, for which item allowance 
 has already been made." 
 
 1 Milwaukee Electric Railway & Light Co. vs. City of Milwaukee, 87 Fed. 577, 585. 
 ^ Ames vs. Union Pac. Ry. Co., 64 Fed. 178.
 
 CHAPTER VI 
 LAND, PAVING, AND WATER RIGHTS 
 
 Land Values. — There has recently developed considerable 
 opposition to permitting utilities to have the unearned increment 
 arising from appreciation in land value. If the investor were 
 guaranteed under all circumstances a fair return on his property, 
 there might be some merit in the argument, that he is not entitled 
 to profits from the unearned increment, but such conditions do 
 not now, and certainly will not obtain in this country, in the near 
 future, consequently valuations of existing utilities proposed to 
 be based on such premises are impracticable. Heretofore in- 
 vestors in utility properties have been encouraged to believe 
 they would be allowed any profits accruing from, rise in land 
 values. If investors are to be allowed none of the chances for 
 gain under advantageous circumstances, and must stand those 
 losses accruing from disadvantageous conditions, the rate of 
 return to be allowed must be increased, but the higher courts 
 have never given any intimation of recognizing anything but 
 present value in consideration of land value. If the utility 
 investing in real estate were not to be allowed the unearned 
 increment, the same result would probably be attained by some 
 circuitous method, such as ownership by individuals leasing the 
 required real estate to the utility at regularly increasing rates, 
 corresponding to the present value of the land, so that, in any 
 case, the public would pay a fair return on the present value of 
 the land. 
 
 The question has been raised that as depreciation of build- 
 ings, for example, is a charge against operation: why should not 
 the appreciation of land be a credit? 
 
 The answer has been well stated by Mr. C. P. Howard: 
 
 "The funds provided for depreciation are a part of the general 
 expense of running the business — maintenance, repairs, and replace- 
 ments. Replacements are, in a way, simply maintenance and repairs 
 on a large scale, and at longer intervals. Depreciation funds take care 
 of replacements. The appreciation of land is entirely different. It 
 
 132
 
 LAND, PAVING, AND WATER h'fdUrs \Xi 
 
 has no necessary and direct connection with operation, or with the special 
 use made of any particular piece of land. In a general way, of course, 
 all industries in the community contribute to it. All other owners of 
 property enjoy this increase as a clear bonus; the unearned increment."' 
 
 We have never heard of any other attempt than that of 
 the Public Service Commission of New York, First District, to 
 deny, in the face of Supreme Court decisions, that the increment 
 in the value of real estate was a part of the utility capital upon 
 which returns must be allowed. In the decision referred to, the 
 Commission said: 
 
 "The present fair value of the real estate has been found from the 
 evidence presented in this case. The difference is the increase between 
 the date of purchase and Dec. 31, 1910. The average annual increase 
 is found by a simple mathematical calculation, similar to that used for 
 fixing annual depreciation. The result is practically S35,000."- 
 
 This average annual increase in real estate value as found 
 in the Kings County case was treated as a part of the annual 
 revenue, and made a part of the total revenues to be allowed 
 the company in fixing rates for a fair return. This action of the 
 Public Service Commission was appealed by the Kings County 
 Lighting Company, first to the Supreme Court and then to the 
 Court of Appeals of New York State, the particular point in- 
 volved being certified to for review, namely: 
 
 "Was the Commission entitled, upon the facts shown in the record, 
 in ascertaining the amount which should constitute a proper return, to 
 consider as part of what accrues to the relator as gross receipts of its 
 yearly operations, the annual appreciation in the value of its land?" 
 
 Both of the Courts appealed to decided against the Commission, 
 holding in accordance with the Supreme Court's previous de- 
 cisions that the present value of real estate is a part of the prop- 
 erty on which the pubhc must pay a fair return. 
 
 While, therefore, public regulation may in some way prevent 
 utilities from hereafter obtaining the benefit of future increment 
 in land values, up to the present time such increment belongs to 
 the owners, whether they are corporations or individuals. 
 
 "There must be a fair return upon the reasonable value of the property 
 at the time it is being used for the public."* 
 
 1 Procefduiss of the American Society of Civil Engineers, February, 1014, Vol. XL. No. -. 
 
 page 9387. ,. , ,, th- 
 
 2 Reports of Public Service Commission of New York, First District, \ ol. II. paRC /u.). 
 * Wilcox vs. Consolidated Gas Company, 212 U. S. 41.
 
 134 VALUE FOR RATE-MAKING 
 
 "As to the justice of the allowance of the so-called unearned in- 
 crement there is a wide divergence of opinion. The pioneer goes out 
 into the forest, and by his detriment of time, labor and privation builds a 
 home. Others follow, and by joint efforts a community is established 
 where once the forest stood. The property of the original settler has 
 now become valuable, and the enhanced value over the actual cost and 
 expenditure of the settler we call the 'unearned increment.' The term 
 'unearned' is a misnomer, for the enhanced value has been fairly earned 
 by years of labor and deprivation. The man who finally reaps the 
 harvest may not be the same individual who sowed the seed. The 
 pioneer may not be able to await the day of the harvest, but if he does, 
 no man will say that the harvest is not rightfully his, or that it has not 
 been fairly earned. 
 
 "So too does the railway company project its Hne into new territory 
 with a full knowledge of the detriments to be overcome. The company 
 considers from the beginning that no adequate return will be made 
 during the early years of its history, but, like the pioneer, it helps to 
 build up a new territory, with confidence that an increment will result 
 sufficient to more than cover the detriment in loss of returns or other- 
 wise. The history of our western country more than justifies the as- 
 surance that such return invariably follows. We have accorded to the 
 individual and to the company the same rule of measurement, and it 
 seems that in all fairness such rule should be applied."^ 
 
 It is practically the unanimous ruling of courts that in de- 
 termining the present fair value real estate must be taken at its 
 existing value, although such value may be less than or many 
 times greater than the original cost. This is a consistent doctrine 
 and is applied logically in ascertaining the value of the property 
 at a given time in the service of the public. 
 
 "It is insisted that in reproduction estimates the enhanced value of 
 property between the time of the original location of a railroad through 
 a wilderness or marsh, it may be, is not to be taken into account 40 or 
 50 years afterward, when civilization, perhaps largely the result of the 
 expenditures and operations of the road, has increased original values a 
 hundredfold. Suppose a road is located when original cost is fabulously 
 inflated, and the course of events brings things down to their intrinsic 
 worth, upon whom does the loss fall? It is usually understood that 
 the state does not make up such losses to its citizens. And, vice versa, 
 when minerals are discovered or oil wells developed on lands, does not 
 the owner of the land own its product? And how are tax values esti- 
 mated? Do the officers take the value when land is first entered and 
 
 ■ Decision of the Washington Public Service Commission, Dec. 24, 1914, fixing rates of 
 the Pacific Northwest Traction Co.
 
 LAND, PAVING, AND WATER RTCIITS 1.^5 
 
 cleared or when it has been improved and becomes a town site? The law 
 is perfectly settled, with the obvious view of the matter, that increments 
 and losses alike attach to ownership as to duties and rights pertaining 
 to property. Willcox vs. Con. Gas Co., 212 U. S. 52, 29 Sup. Ct. 192, 
 53 L. Ed. 382; Stanislaus vs. Irrigation Co., 192 U. S. 215, 24 Sup. Ct. 
 241, 48 L. Ed. 406; San Diego Land Co. vs. National City, 174 U. S. 757, 
 19 Sup. Ct. 804, 43 L. Ed. 1154. And this just rule has its balances and 
 adjustments making it not oppressive to the public in any case. It is 
 to be noticed, too, that the rates in fact usually diminish with the in- 
 crease in property values, because the increase of business dominates 
 values and justifies lower rates; but, be that as it may, the rule of giving 
 to the owner the increments of value and subjecting him to the losses in 
 values has the unequivocal sanction of the law."^ 
 
 Paving. — In the last two or three years there have been many 
 authoritative decisions as to the value to be allowed for street 
 pavements in rate-making. While the drift of opinion seems 
 to be toward allowing the utility the value of pavements neces- 
 sarily laid by it in installing and constructing its structures 
 beneath street surfaces, excluding the value of all such pavements 
 as have been laid at the expense of the public since the con- 
 struction of utility property in the streets, nevertheless, the 
 question cannot yet be considered as fully and finally settled. 
 The present difficulties are doubtless largely due to the failure 
 to appreciate and keep clearly in mind the difference and dis- 
 tinction between cost and value. If the fundamental purpose 
 of the inquiry is to ascertain the actual investment, then only 
 the cost of such paving as has been laid by the corporation should 
 be considered; if, however, the cost of reproduction new is being 
 ascertained, then the estimated cost of replacing all paving neces- 
 sary to be laid in recreating the existing substrect structures must 
 be taken. Modifications of either of the above methods may be 
 advisable or necessary in order to determine facts upon which 
 to base conclusions as to value. For example, it may be de- 
 sirable to ascertain exactly how much pavement has been put 
 down at the expense of the corporation; in other instances, pav- 
 ing over services connected with gas or water mains is sometimes 
 paid for by the consumer, and in such cases the corporation has no 
 rightful claim whatsoever that the value of such pavement should 
 be included in the value of its property. It may be assumed 
 that in every case the pavement in the street does not belong to 
 
 1 Louisville & Nashville R. R. Co.. vs. Railroad Commission of Alabama. 196 Fed. 821.
 
 136 VALUE FOR RATE-MAKING 
 
 the corporation, regardless of whether the pavement is laid before 
 or after the construction of the subsurface structures, or has been 
 paid for by the corporation or the municipality. 
 
 Although the flat-footed decision of the Supreme Court in 
 the Consolidated Gas Company case still stands, wherein the 
 cost of reproducing all paving, whether laid before or after the 
 subsurface structures were installed, was allowed in the value 
 made the basis of rates, nevertheless, a more recent opinion of 
 the United States Supreme Court in the Des Moines gas case 
 reverses the previous position of the same court as announced 
 in the Consolidated Gas case. The Supreme Court was called 
 upon to decide an appeal from the District Court for the 
 Southern District of Iowa to reverse a decree dismissing a bill 
 which sought to enjoin the enforcement of a municipal ordinance 
 fixing gas rates in the City of Des Moines. Judge Day, who 
 wrote the opinion, refers to the master's report as giving "evi- 
 dence of very thorough consideration of the subject," and refer- 
 ring to the exclusion of an item of $140,000 by the master, the 
 estimated cost of replacing pavements laid after gas mains were 
 installed, says: 
 
 "As to the item of $140,000, which, it is contended, should be added 
 to the valuation, because of the fact that the master valued the property 
 on the basis of the cost of reproduction new, less depreciation, and it 
 would be necessary in such reproduction to take up and replace pave- 
 ments on streets which were unpaved when the gas mains were laid, in 
 order to replace the mains, we are of the opinion that the Court below 
 correctly disposed of this question. These pavements were already in 
 place. It may be conceded that they would require removal at the 
 time when it became necessary to reproduce the plant in this respect. 
 The master reached the conclusion that the life of the mains would not 
 be enhanced by the necessity of removing the pavements, and that the 
 company had no right of property in the pavements thus dealt with, 
 and that there was neither justice nor equity in requiring the people who 
 had been at the expense of paving the streets to pay an additional sum 
 for gas because the plant, when put in, would have to be at the expense 
 of taking up and replacing the pavements in building the same. He 
 held that such added value was wholly theoretical, when no benefit 
 was derived therefrom. We find no error in this disposition of the 
 question."^ 
 
 In answer to the Court's objections, given above, there could 
 appropriately be quoted the very complete and logical statement 
 
 ' Dos Moines Gas Co. vs. City of Des Moines et al., 35 Supreme Court Rep. 811.
 
 LAND, PAVING, AND WATER RIGHTS 137 
 
 of the Federal Court, in the Louisville and Nashville Railroad 
 case, as to why the unearned increment in real estate is tlic 
 property of a utility. The opinion is given on pages 134 and 135. 
 
 The California Commission has uniformly adopted the policy 
 of allowing the value of paving only in case the same has l)een 
 paid for by the utility regardless of whether the case is a rate or 
 purchase and sale case. The Indiana, Arizona, New Jersey, 
 in some instances New York, and many other Public Service 
 Commissions have followed the same precedent. 
 
 On the other hand; a number of state commissions have held 
 that all paving over subsurface structures owned by public utiHty 
 corporations should be included in the value of the property of 
 the latter in cases of purchase, sale or taxes. In its valuation of 
 the property of the Appleton Water-works Company, the Rail- 
 road Commission of Wisconsin included the value of pavement 
 over mains, even though it had been laid without expense to the 
 company, excluding, however, the cost of pavement over service 
 pipes as they had been paid for by the consumers, although at the 
 time of the valuation they were owned by the utility. The 
 Supreme Court agreed with the Commission in refusing to 
 allow the value of the paving over the services, and in allowing 
 the value of the paving over mains, saying: 
 
 "Cost of reproduction must mean the cost which will be necessarily 
 incurred by a reasonably prudent and careful man, using ordinary care- 
 ful business methods, in producing a plant of equal efficiency. Anything 
 which under such a conduct of the business would cost nothing to repro- 
 duce cannot logically be included. It is not denied that if the city or a 
 new water company were to establish a new plant the consumers could 
 be required, as a condition of receiving water service, to do the work in 
 question, and even furnish the pipe; such a requirement is quite generally 
 enforced at the present time in cities of this class. * * * This is not 
 the case where land or other property of value has been voluntarily 
 donated to the old company. With regard to such property it has been 
 held in cases involving the fixing of rates that it is rightfully to be con- 
 sidered in arriving at the cost of reproduction. This result is reached 
 on the idea that a new company could not count on receiving such gifts. 
 Whether the logic of these cases be correct or not, we do not decide, 
 but in any event the principle does not apply to expenses which may 
 legally be assessed, and in the exercise of good business judgment ought 
 to be assessed, against the consumer. For purchase purposes at least 
 the only expenses which could be considered in the estimate of the cost
 
 138 VALUE FOR RATE-MAKING 
 
 of reproduction are those which are reasonably necessary in a prudently 
 conducted reproduction."' 
 
 In the Oshkosh Water-works Company case, the Wisconsin 
 Commission considered and followed the rule which they had 
 laid down in the Appleton case, which had received the approval 
 of the Supreme Court. 
 
 In its opinion the Commission says: 
 
 "It is conceded that in reproducing a plant of efficiency equal to that 
 of the existing plant it would be necessary to cut through all paving 
 under which existing mains lie and that the cost of removing and relay- 
 ing the paving would be a part of the construction cost. This principle 
 was recognized and applied by the Commission in the Appleton case 
 (m re Appleton W. W. Co., 1910, 6 W. R. C. R. 97, 122) and subse- 
 quently affirmed by the Supreme Court of this state in the case cited 
 above. "^ 
 
 In a New York tax case the Appellate Division held that the 
 reproduction cost of pavement laid with or without expense to the 
 utility should be included in the value of a special franchise under 
 the net earnings rule: 
 
 "When the pipes were laid in certain streets they were unpaved, and 
 afterward the city paved the streets. In determining the reproductive 
 cost of laying the pipes in those streets the cost of relaying the pavement 
 was not allowed as a part of the reproductive value. We think it should 
 have been. The fact that the paving cost the company nothing is 
 immaterial."^ 
 
 In line with the preceding decisions, the Maryland State 
 Commission has very ably summarized the existing situation as 
 to the valuation of pavements. 
 
 "While it is true that were this company not already in the field, and 
 were it necessary for it or some other company to reproduce the property 
 as it stands, it would be necessary to remove and replace the paving of 
 the streets where its mains and pipes have heretofore been laid. It is 
 to be borne in mind that the real effort of the Commission in all inves- 
 tigations of this character is to ascertain the fair value of the property 
 actually used in the public service, and that the cost of reproducing 
 such property is only one of the many elements to be considered in 
 determining what is that actual value. The reproduction value is not 
 
 > Appleton Water-works Co. vs. City of Appleton, 142 N. W. 481. 
 ^ In re purchase, Oshkosh Water-works plant, 12 W. R. C. R. 662. 
 3 157 Appellate Division 165, 142 N. Y. Supp. 180, May 22, 1913.
 
 LAND, PAVING, AND WATER RIGHTS VM) 
 
 in itself the actual value; it simply reflects upon that value, just as it 
 would reflect upon the market value, if market value were the inquiry. 
 
 "The question as to whether or not the value of paving laid over and 
 after the installation of gas pipes, water mains, or other subsurface 
 structures should be included is a mooted one. In rate cases some 
 authorities have disallowed the value of such pavement in fixing ade- 
 quate return upon investment value, but as far as we are aware, the 
 courts have uniformly held where value has been determined in purcha.se 
 and sale cases, from a consideration of reproduction cost, that the value 
 of all paving that would be disturbed by replacing the existing property 
 should be included, regardless of the fact whether such paving was laid 
 after or before the subsurface structures were installed. In rate cases, 
 therefore, it may be material to separate the value of paving into that 
 which has been cut through by the installation of pipes, mains, or other 
 structures, and that which has been laid after the installation of such 
 structures, but in purchase and sale cases, it would seem that the total 
 value of the paving must be considered, because the question to be 
 determined is not investment value but present value. It must be 
 conceded that the purchase price of property may be, and often is, less 
 than the owner's investment. It may be, where the facts warrant, that 
 the purchase price is much larger than the owner's investment. In 
 determining the rate to be allowed the owner, it may, under certain 
 circumstances, be fair to fix the rate from a consideration of the owner's 
 investment, but usually the question to be determined is present value, 
 not original value." ^ 
 
 Water Rights. — In order to determine the basis on which to 
 predicate the value of rights to or ownership in water, con- 
 sideration should be given the development of existing laws 
 and priority of use of water. The State and National laws of 
 the United States, which relate to the control and use of non- 
 navigable water, are far from being generally satisfactory. The 
 existing laws are the result of conditions which have since greatly 
 changed. The fundamental principle heretofore generally recog- 
 nized in connection with non-navigable water is that the water 
 may not be permanently diverted from its natural channel. 
 Following British practice, the American courts and legislatures 
 in the Eastern part of the United States have been accustomed 
 to hold that the natural flow of a stream may not be interrupted 
 or diverted to the detriment of any riparian owner farther down 
 the stream, the right to use the water belonging to the individual 
 who controls the banks of the stream. With the development 
 
 • 24 A. T. & T. Co. Com. L. .564, Aug. 27. 1913, Maryland Public Service CommiBsion.
 
 140 VALUE FOR RATE-MAKING 
 
 of the country and a growing public necessity for the diversion 
 of water from its natural channel for various purposes, especially 
 for municipal and irrigation use, the old riparian law is being 
 modified by the right of appropriation and diversion. The 
 latter principle has been very generally accepted in the West, 
 where it is frequently necessary to divert water from its natural 
 channels and convey it to distant points in order that it may be 
 used most beneficially. 
 
 As conditions change, law and government may be modified 
 to insure the greatest good to the greatest number. Conse- 
 quently, the undue precedence given the use of water for naviga- 
 tion by the national authorities is being modified because largely 
 obsolete, the most important use of water being in connection 
 with the life and health of humanity. The order of the preced- 
 ence to be recognized in granting the use of water is well set forth 
 in a report of a special committee of the American Society of 
 Civil Engineers "on a national water law": 
 
 " (a) The first use of water in importance and the one truly para- 
 mount, namely, that for the domestic or household requirements of man 
 — one without which life itself must disappear — was not recognized as 
 of sufficient consequence for consideration when the rights of naviga- 
 tion received their present prominence in this country. At the time of 
 the adoption of the Federal Constitution, outside of New York City 
 and Bethlehem, Pa., municipal or public water supplies appear to 
 have been non-existent in America. 
 
 (b) The second use of water, in present importance, is that for the 
 watering of live stock and the production of crops, upon which two 
 factors depend the food supplies of the nation. The former of these 
 applications is long recognized and well established, but the latter, now 
 reaching its highest development in the vast irrigation systems of the 
 arid and semi-arid States, is a use almost unknown in this country 
 prior to the Civil War. Coordinate with this use, and as a necessary 
 adjunct in many cases, is the drainage of lands rendered unproductive 
 by an excess of water. 
 
 (c) The third in relative importance is the use of water in the dis- 
 posal of city sewage, for, whether with or without preliminary treatment, 
 the sewage from inland cities must of necessity be carried away and 
 finally disposed of in natural waterways, which are a part of the great 
 circulatory system of the country ; and the right to the use of water for 
 this purpose must be clearly recognized. 
 
 (d) The fourth use is that for manufacturing, and for the generation 
 of power to be used in the production of the requisites of civilization.
 
 LAND, PAVING, AND WATER RICllTS \ 
 
 II 
 
 The former is practically inseparable from the domestic uses in an 
 ordinary municipality, but the latter is a larger, more specific and more 
 easily distinguished use and is commonly designated power development. 
 Closely related to the above is the preservation of property by \nu- 
 tection against floods and the regulation of the stream flgw to this end, 
 as well as with a view to an increased utilization of the water. 
 
 (e) The fifth use is that for the transportation of the products of 
 agriculture and the materials of manufacture, and for the convenience 
 of travel, designated as navigation."^ 
 
 Although many individual states claim the right to control 
 all waters within their respective boundaries, the Federal Govern- 
 ment has assumed the right to limit and control the use of waters 
 on so-called public lands or in navigable streams, and in certain 
 instances has prohibited the use of water, regardless of riparian 
 ownership, even absolutely preventing the extension and com- 
 pletion of projected hydraulic developments, for example, at 
 Niagara Falls, New York. 
 
 Under the law of appropriation, regardless of previous land 
 grants or concessions or proprietorship in underlying or adjoining 
 real estate, an individual or corporation may appropriate and use 
 for any beneficent purpose the unappropriated waters of any 
 stream. This doctrine limits the right to appropriate unappro- 
 priated water merely by the requirement that the water shall be 
 actively and beneficially used. 
 
 The Western States particularly argue that as they were ad- 
 mitted into the Union upon an equal footing with the other 
 states, they were given absolute control of waters within their 
 boundaries and that, therefore, the Federal Government has no 
 right to the control of the waters. A study of the decisions of 
 the courts seems to indicate that there is no clear and con- 
 clusive finding to sustain their views. 
 
 The contention of the advocates of the doctrine that the States 
 own and control both the navigable and non-navigable waters 
 within their boundaries is usually based upon a line of decisions 
 of the Supreme Court, particularly Pollard vs. Hagan,^ where the 
 point at issue was "whether Alabama is entitled to the shores of 
 navigable waters, the soils under them, within her limits," the 
 land in question being ''covered by the water of the Mobile River 
 at common high tide." The Court held that "the shores of 
 
 « Presented to the Annual Meeting, Jan. 19, 1916. 
 ^ John Pollard et al. vs. John Hagen et ah, 3 How. 212.
 
 142 VALUE FOR RATE-MAKING 
 
 navigable waters and the soils under them" are reserved to the 
 States, whether one of the original thirteen States or one of those 
 later admitted to the Union. The decision has, in fact, nothing 
 whatsoever to do with water rights, but deals with title to land. 
 Another case cited by the adherents of State rights is Kansas 
 vs. Colorado, which involved a controversy between two States 
 as to the diversion and use of water from the Arkansas River. 
 The Court in that case stated : 
 
 "That if in the present case the National Government was asserting, 
 as against either Kansas or Colorado, that the appropriation for the pur- 
 poses of irrigation of the waters of the Arkansas was affecting the naviga- 
 bility of the stream, it would become our duty to determine the truth of 
 the charge. But the Government makes no such contention."^ 
 
 From the above it will be seen that one Federal question was 
 eliminated from the case and with regard to another, namely, 
 the authority of Congress to provide for the irrigation of arid 
 lands, the Court said, discussing Section 3 of Article IV of the 
 Constitution : 
 
 "But clearly it does not grant to Congress any legislative control over 
 the States and must, so far as they are concerned, be limited to authority 
 over the property belonging to the United States within their limits."^ 
 
 The Court does not seem to hold, in the above case, that 
 water was not the property of the United States. That con- 
 tention was not made, and the decision of the Court upon the 
 issue raised between the two States mentioned was: 
 
 "It is enough for the purposes of this case that each State has full 
 jurisdiction over the lands within its borders, including the beds of 
 streams and other waters."' 
 
 In Jennison vs. Kirk^ the Supreme Court rendered a decision 
 construing a Federal statute. Revised Statutes 2339, which 
 expressly recognized or vaHdated rights to the use of waters for 
 mining, agricultural and certain other purposes in those cases 
 where the vested rights were recognized and acknowledged by 
 local customs, laws and decisions of the courts. 
 
 Another decision, Broder vs. Water Company,^ is to the 
 same effect as the preceding, and neither in the statute mentioned 
 nor in the decision is there any grant or admission by the Court 
 
 • Kansas vs. Colorado, 206 U. S. 46. 
 - 98 U. S., 453. 
 3 101 U. S. 274.
 
 LAND, PAVING, AND WATEIi RICIITS l |;{ 
 
 that the States own or control the waters witliin the puhhc hinds 
 or reservations. The statute referred to seems to be in the 
 nature of a vaUdation of possessory rights initiated in trespass 
 or at least without specific authority, for if it was a recognition 
 of the fact that the States control the water, why was the enacl- 
 ment of a Federal statute necessary? Examination of the 
 enabling acts or grants to the various States does not seem either 
 in specific language or in any other way, unless by implication, 
 to convey the waters to the States, and if title thereto be in the 
 Federal Government, and not conveyed l)y such acts, the title 
 to the waters and the control thereof are still the property of 
 the United States the same as are the areas of public land within 
 the same States. 
 
 In Light vs. United States, speaking of govcrnmciit-owncd 
 lands, the Supreme Court said: 
 
 " 'The Government has with respect to its own lands the rights of an 
 ordinary proprietor to maintain its possession and prosecute trespass- 
 ers. It may deal with such lands precisely as an ordinary individual 
 may deal with his farming property. It may sell or withhold them from 
 sale.' Camfield vs. United States, 167 U. S. 524. . . . the Consti- 
 tution declares, §3, Article IV, that Congress shall have power to 
 dispose of and make all needful rules and regulations respecting the 
 territory or the property belonging to the United States. The full 
 scope of this paragraph has never been definitely settled. Primarily, 
 at least, it is a grant of power to the United States of control over its 
 property." 1 
 
 In the case of Winter vs. United States, certain white citizens 
 of the State of Montana had appropriated under State laws and 
 were undertaking to use water of Milk River. The United 
 States enjoined such use on the ground that under an agreement 
 the water was reserved for the use and benefit of the Indians 
 of the Fort Belknap Reservation, and that being so reserved the 
 water could never become subject to appropriation under State 
 laws. The Court in this case said : 
 
 "The power of the Government to reserve the waters and exempt them 
 from appropriation under the State laws is not denied and cannot he."* 
 
 A similar ruling was made, in respect to water reservetl for the 
 Black Feet Indians, in Conrad Investment Company vs. United 
 
 > 220 U. S. 523. 
 ^ 207 U. S. 564.
 
 144 VALUE FOR RATE-MAKING 
 
 States.^ It should be pointed out that at the time of the agree- 
 ment with the Indians, the country involved was a territory 
 and had not yet been created into a State and admitted into the 
 Union, but it may be questioned whether the change from terri- 
 tory to State would alter the Court's ruling. 
 
 The general policy of Congress and the United States, with 
 respect to the national parks or other similar reservations, is well 
 known and recognized. In several instances, at least, the States 
 have conceded or disclaimed civil and criminal jurisdiction within 
 reserved limits, and recognized the Government's control of 
 certain lands, timber, objects of interest, etc. The right of a 
 State, if it had one, to waters on Government land or within 
 reservations would be artificial and ineffective, because the State 
 has no right to enter upon such Government-owned land adjoin- 
 ing the stream, or to divert water from the riparian owner. 
 
 Without referring to other cases that might be cited, in Gibson 
 vs. Chouteau, with regard to the public domain, the Supreme 
 Court said : 
 
 "No State Legislature can interfere with this right or embarrass its 
 exercise."- 
 
 In a more recent case, where a public utility corporation 
 claimed the right to appropriate and use waters of a stream on 
 Government-owned land for hydro-electric development without 
 first obtaining permission from the United States Government, 
 the Circuit Court of Appeals, Eighth Circuit, sustained the con- 
 tention of the Government that such action was trespass and 
 unauthorized, saying: 
 
 "The proposition that absolute and perpetual rights in the public 
 lands may be acquired for private gain by a mere appropriation without 
 purchase or compensation and in the exercise of a State sovereignty, 
 which transcends the constitutional power of the Congress, is a some- 
 what startling one."^ 
 
 This case is now pending before the United States Supreme 
 Court on appeal. It is hoped that the Court's finding in this 
 case may definitely and finally settle all controversies as to ques- 
 tions of the State's ownership and control of water within its 
 boundary. 
 
 ' 161 Federal 829. 
 
 * 80 U. S. 92. • 
 
 « United States vs. Utah Power & Light Co.
 
 LAND, PAVING, AND WATER RIGHTS 145 
 
 The right of a State to control the waters within its boundaries 
 does not extend to water on Government-owned land unless Con- 
 gress has conferred such right upon the State. In fact, t he right of 
 the State to control waters within its boundaries rests upon the same 
 principles and goes only as far as the right of any other private 
 or pubHc riparian proprietor. Although nearly all the Western 
 States are unanimous in asserting the exclusive control l)y the 
 State authorities of all waters within their boundaries, and al- 
 though the State of California has perhaps gone as far, if not 
 farther, than any of the other Western States in these claims, 
 nevertheless, the Superior Court of that State has itself very 
 definitely and convincingly held that the State's rights to th(! 
 waters are no more nor no less than the State has through 
 ownership of riparian lands. 
 
 "The theory that the water of a non-navigable stream in this State is 
 in some sense 'public water' has been advanced before. It has been 
 claimed that a diversion of water under the provisions of the Civil Code 
 (Sees. 1410 to 1422) constitutes a grant of the water by the State to the 
 appropriator. The idea may have arisen from the statement sometimes 
 made in the decisions that the riparian owner has no right in the corpus 
 of the water (Eddy vs. Simpson, 3 Cal. 252), and that running water 
 cannot be made the subject of private ownership, that the right to use 
 the water of a stream 'carries no specific property in the water itself 
 (Kidd vs. Laird, 15 Cal. 179). This is far from saying that the property 
 in the water is vested in the public, either for general use or as property 
 of the State. The doctrine that it is public water, or that it belongs to 
 the State because it is not capable of private ownership, has no support 
 in the statutes of the State or in any decision of this court. 
 
 "The true reason for the rule that there can be no property in the corpus 
 of the water running in a stream is not that it is dedicated to the public, 
 but because of the fact that so long as it continues to run there cannot be 
 that possession of it which is essential to ownership. It is in this respect 
 similar to the air, which cannot be said to be possessed or owned by any 
 person unless it is confined within impervious walls. One may have the 
 right to take water from the stream, even the exclusive right to do so, 
 but in that case he does not have the right to a specific particle of water 
 until he has taken it from the stream and reduced it to possession. 
 It then ceases to be a part of the stream. Such right to the water of 
 running streams as there is under the law is vested entirely in the several 
 riparian owners along its course. It is subject to the common use of all 
 riparian owners, but neither has a specific property in any part of the 
 water while it remains running in the stream. The United States, with 
 respect to the lands which it owns in the State, is a riparian pro- 
 
 10
 
 146 VALUE FOR RATE-MAKING 
 
 prietor as to the streams running through such lands. It is only by- 
 virtue of that fact that it has any right or power of disposition over 
 the waters thereof. And its right and power in that respect is no 
 greater and no less than that of any other riparian proprietor. By 
 the act of July 26, 1866 (14 U. S. Stats. 251), the United States 
 consented that private persons might acquire rights to water flowing 
 in streams through its lands by taking possession thereof, that is, 
 by diverting the same in such manner as should be provided by the 
 laws of the particular State. Where such diversion had not been made, 
 a grant of its lands bj' the United States to a private person without 
 reservation would carry with it the riparian rights pertaining to that 
 land in streams flowing through it, in the same manner as in the case of a 
 grant of land by a private owner. So, also, the State, with respect to 
 the lands it owns which are not devoted to a specific public use, is in the 
 same category as any other land owner. It has riparian rights with 
 respect to such land in the streams running over it, which its grant carries 
 to the grantee. The provisions of the Civil Code above mentioned have 
 the effect of a declaration by the State that any person who may divert 
 water from a stream in pursuance of those provisions will thereby ob- 
 tain a right in the stream paramount to the riparian rights which the 
 State may have therein by virtue of the fact that the stream may run 
 over lands then belonging to the State. To that extent it operates as a 
 grant from the State, but this is only because the State had the riparian 
 right, and not because the water was in any sense public water devoted 
 to public use."^ 
 
 In determining the value of water rights there must be had a 
 clear conception of what the owner of such rights is entitled to. 
 The Supreme Court of the State of California has rendered an 
 interesting decision indicating the limits to which water rights 
 may extend even in the Western States. The case hinged on the 
 right of the defendant to divert so-called freshets or flood flows 
 of the Fresno River. The plaintiff owned riparian land and con- 
 tended that it was entitled to all the rights pertaining to riparian 
 ownership, that the freshet or flood flows occurred in almost every 
 season of normal rainfall and therefore could not be diverted by 
 the defendant. The Court spoke as follows: 
 
 "It is suggested that a different rule should apply in a semi-arid cli- 
 mate like that of California, where the fall of rain and snow occurs during 
 only a limited period of the year and, consequently, streams carry in some 
 months a flow of water greatly exceeding that flowing during the dry 
 season, with the result that such increased flow is not, at all points, con- 
 
 ' Palmer et al. vs. Railroad CommisBion of the State of California 'et al, S. F. No. 6555, 
 page 201.
 
 LAND, PAVING, AND WATER lUailTS i 17 
 
 fined within the banks which mark the Umits of the stream at low water. 
 But no authority has been cited, and we see no sufficient ground iti 
 principle, for holding that the rights of riparian proprietors should be 
 limited to the body of water which flows in the stream at the period of 
 greatest scarcity. What the riparian proprietor is entitled to as against 
 non-riparian takers is the ordinary and usual flow of the stream. There 
 is no good reason for saying that the greatly increased flow following the 
 annually recurring fall of rain and melting of snow in the region about the 
 head of the stream is any less usual or ordinary than the much di- 
 minished flow which comes after the rains and the melted snows have 
 run ofT. Perhaps other considerations should apply where a river, in 
 times of heavy flow, runs over its banks in such manner that large vol- 
 umes of water leave the stream and spread over adjoining lands to an 
 indefinite extent, there to stagnate until they evaporate or are absorl)od 
 by the soil. But the evidence of respondent, and this was the evidence 
 on which the court below acted, fails to show that the water which de- 
 fendant seeks to divert was such 'vagrant water.' The evidence of 
 respondent was to the effect that at all seasons the water of the Fresno 
 River, even though overflowing the banks of the channel in wliich it flowed 
 during the dry season, formed a single and continuously flowing stream."' 
 
 The State regulating commissions have often failed to recognize 
 and allow any value for water rights, as such, in addition to the 
 values of other intangible elements or the physical property 
 itself. This attitude is shown in the decision of the Public 
 Service Commission of New York, Second District, decided in 
 the matter of rates of the Cataract Power & Conduit Company: 
 
 "Such results as these will never satisfy the elementary sense of right 
 and justice in the mind of any man with regard to the use of Niagara 
 generated electric energy. No generating company using the water of 
 Niagara River owns those waters or has any right or title to them what- 
 soever. By the permission of the Federal Government and of the State 
 of New York, the generating companies operating at the Falls are given 
 the free use of those waters in the production of electric energy. To say 
 that by having been given the free use of those waters for that purpose 
 they are vested with an unassailable right to charge as much for the 
 electric energy developed as they would for energy developed by steam 
 plant is a proposition which requires to be maintained rather than to 
 be refuted. It may very well be that these companies are entitled, m 
 view of all of the circumstances of the case, to a liberal return upon the 
 capital actually invested in developing the energy. It may very well be 
 that the people exploiting the enterprise are entitled to large, and even 
 
 . Miller & Lux vs. Madera Canal & Irrigation Co.. XXXVII. California Decisions No. 
 1900, page 115.
 
 148 VALUE FOR RATE-MAKING 
 
 very large, profits for the skill they have displayed and the risk to which 
 they have subjected their capital. It may be that the pubhc ought to 
 pay them very liberally for the work which they have carried on in the 
 public interest; but to say that the public is entitled to no advantage 
 from the use of these waters, that the territory which can be served with 
 electric energy developed at Niagara Falls has no advantage and is 
 entitled to no benefit by reason of proximity to those Falls, is to say 
 something which does not appeal to the best judgment of mankind for 
 an instant."^ 
 
 It may be noted that the Commission after writing the above 
 as to "a liberal return upon the capital actually invested" held 
 that the rates should be reduced so that the fair return was 
 "approximately 6 per cent." upon the "capital invested in the 
 public service." It is only fair to state in passing that the 
 company did not claim "the public is entitled to no advantage 
 from the use" of water-power-produced as against steam-pro- 
 duced, electric energy but rather it proposed to divide its profit 
 equally between the public and itself. 
 
 There has existed a tendency to regard water right values as 
 analogous to franchise values and without value. 
 
 "What has been heretofore said concerning the inclusion of other in- 
 tangible value, such as 'going concern,' 'good will' and 'franchise 
 value' would apply to the inclusion of what is termed 'unearned 
 increment value,' accruing by reason of the right to the use of water for 
 the purposes to which it has been dedicated. We find, from a careful 
 examination of the authorities cited, and these examined in our own re- 
 search, that the courts and public utilities commission refuse to allow a 
 valuation of this character other than the actual cost thereof for the pur- 
 pose of fixing rates. "2 
 
 In the case where a corporation acquires no proprietary interest 
 but merely has a franchise to appropriate water for diversion, 
 transportation and sale, it may be conceded the right of diversion 
 is merely equivalent to a franchise right but that is distinct and 
 different from value in the ownership of water rights. 
 
 "There is a striking analogy between the appropriation of water for 
 beneficial purposes and the location of a mining claim. Neither the 
 appropriation nor the location gives to the party claiming thereunder 
 
 ' Decision of Public Service Commission of New York, Second District, in re Fuhrman 
 vs. Cataract Power & Conduit Company, decided Apr. 2, 1913. 
 
 ^ Decision of Public Utilities Commission of Idaho, Apr. 13, 19M, in re application of 
 Pocatello Water Co.
 
 LAND, PAVING, AND WATER RK.'flTS i lii 
 
 the absolute ownership in fee. Under the appropriation laws lawful 
 possession of the water is dependent upon its being used for some bene- 
 ficial purpose. Under the mining location laws the {xjssession f)f the 
 mining claim is dependent upon the performance of a certain anion rit of 
 development work upon the claim each year. As long as these conditions 
 are performed, the appropriator of the water and the locator of the 
 mining claim are fully protected by law in the possession of the respective 
 properties. A water right is not an intangible thing, l)ut is in the highest 
 degree tangible. A water right without water would be worth sinii)iy 
 nothing at all. There can be no such thing as a water right with(jut 
 water, and water is not only property of a substantial nature, but it is 
 included in the class of the highest grade of property, viz., real property, 
 and, in its possession, transfer, and enjoyment, is governed generally 
 by the same laws as those applying to land. 
 
 "Nowhere in any of the California decisions can be found anj' state- 
 ment to the effect that a water right, within the meaning of the law, is 
 not a thing of value. In the cases referred to, the decision of the courts 
 was that the water companies had no water rights but simplj' franchises 
 to render a service. Water companies engaged solely in the business of 
 distributing and selling water are referred to as agencies. The owner- 
 ship of the water is regarded as being still in the people and the compa- 
 nies as being merely invested with the franchise right of taking the water 
 from its natural channels and delivering it to the people at reasonar)le 
 prices for the service rendered." 
 
 ******** 
 
 "In the recent case of Tonopah Water Company vs. PubHc Service 
 Commission of Nevada the attitude of Judge Morrow with respect to the 
 value of water rights was made entirely clear. The case of San Joaciuin 
 and Kings River C. &I. Company vs. Stanislaus County, in 191 Fed., was 
 decided about two years before the hearing was had in the Tonopah 
 water case. And yet at no stage of the proceeding did Judge Morrow 
 utter a word which gives the slightest support to the theory that the 
 water rights of a public service corporation are not to be considered as of 
 value. In his revised opinion that distinguished and learned judge 
 accepts, as intrinsically sound, my own contention made when actmg as 
 counsel in the case, that the Tonopah Water Company had no 'water 
 right' within the meaning of the law; that the only water it possessed 
 was percolating water, and, as such, a part and parcel of the soil. The 
 Court held substantially in accordance with this view, and further held 
 that there was no evidence that the Court could consider, proving the 
 value of the water considered as a water right. But running all through 
 the Judge's remarks when engaged in colloquy with the attorneys, as 
 well as through the final opinion, was a clear indication of the view that a 
 water right was a thing of value, properly to be considered when its value
 
 150 VALUE FOR RATE-MAKING 
 
 was clearly shown. The trouble in that case was that all the evidence 
 offered by the water company went to the value of a water right, per se, 
 while it was made very apparent that there was no such water right, but 
 that the company was simply the owner of a piece of ground saturated 
 with water."^ 
 
 The term "water rights" is used indiscriminately, whether 
 applied to the values possessed by corporations diverting water 
 for irrigation or sanitary purposes, or those using water perhaps 
 on their own real estate for power development. It will be 
 recognized that the value for the former purpose in any particular 
 instance might be and usually is quite different from the value for 
 power purposes and vice versa. Consequently, the method of 
 measuring or determining the value of water for power develop- 
 ment may not be applicable in determining the value of water for 
 diversion, sanitation or irrigation. 
 
 A general method frequently applied to determine the value of 
 any class of water rights is the "next available source of supply." 
 This consists in estimating the excess in cost of plant and prop- 
 erty, of the next nearest supply that might be made available, 
 above or beyond the existing property, which excess cost is used 
 as the basis from which to derive the value of the water rights of 
 the existing property. 
 
 "To illustrate: If it costs $120 a year more to haul farm produce 
 from farm A than from farm B, and if money is worth 6 per cent., then 
 the capitalized value of this $120 annual difference is $2,000. Hence, 
 if all other things are equal, farm B has a value of $2,000 in excess of 
 farm A. Similarly if a distant water supply A causes an annual cost 
 that is $6,000 greater than is incurred with supply B, then supply B 
 has a value of $100,000 in excess of supply A, if money is worth 6 per 
 cent." 2 
 
 Where the power is being developed the value of the water 
 rights is frequently estimated by a similar method except that 
 the "next available source of supply" is not another water power 
 but some other type of motive power such as steam or oil. The 
 Railroad Commission of Wisconsin early appreciated the impor- 
 tance of this method of evaluating water rights and in several 
 decisions analyzed and discussed the method but only recently 
 accepted such engineering calculations as the basis of an award. 
 
 ' Pul)lic Service Commission of Nevada vs. Nevada & California Power Co., Jan. 29, 
 1914, pages 30-39. 
 
 ^ Engineering <t Contr acting, .July 8, 1914.
 
 LAND, PAVING, AND WATER RICUTS l.-ii 
 
 The views of the Commission are {iiveu in tlic tolldwintr cxtiads 
 from its decisions: 
 
 "That, as a rule, water powers have some vahie that shouUl he con- 
 sidered, but there are wide differences of opinion as to what tliese vahics 
 amount to. In estimating the vahie of water rights, it seems to bo cuin- 
 mon practice among engineers to compute what it would cost to operate 
 a steam plant in the same locaUty, under the same load and condi- 
 tions. Finding by this calculation the cost per horsepower per year for 
 the steam plant, the actual cost per horsepower per year of the existing 
 water power plant is sul)tracted therefrom, and the saving of the water 
 power over the steam power, as shown in the remainder, is called the 
 value of the water right. In this way steam and water power plants are 
 ostensibly placed on the same basis. 
 
 "From a purely commercial point of view this method of estimating 
 the value of water power may, in the main, be sound. But it is not .so 
 clear that this can be said for it when the question is regarded from the 
 point of view of pubUc policy. This method, as stated, places water 
 and steam plants on the same basis. By doing this it necessarily diverts 
 all the advantages that may accrue from such water powers from the 
 pubhc to the private owners. In other words, it appears to deprive a 
 locality of the natural advantages it might otherwise derive from being 
 located near such water powers. If water rights are private property 
 under the law, then all the benefits which accrue from these rights would 
 probably go to their private owners. If, on the other hand, water j)o\v('r 
 rights are public rights rather than private rights, then it would also 
 seem that the public ought to share in any benefits that may be derived 
 from such rights. Just what the law is in this respect, is a matter upon 
 which we will not attempt to pass at this time. 
 
 "As to whether the respondent's plant can generate and distribute its 
 current at relatively lower costs than a modern steam plant just large 
 enough to furnish all the current needed for the city of Hudson, is not 
 entirely clear. The comparisons we have made and. the data we have 
 collected for the purpose of determining this question indicate a small dif- 
 ference in favor of the present plant. At any rate, the present plant 
 appears to be in a position to generate current at a somewhat lower cost 
 than a steam plant. When it comes to the distribution of the current 
 and to the fixed charges, on the other hand, the situation would almost 
 seem to be reversed, for the distribution expenses and the fixed charges 
 of the present plant appear to be fully as high as would be the case for a 
 steam plant. Some of the reasons for this are found in the location of 
 the plant, and in the fact that the present plant had to provide and has 
 to maintain two separate dams or generating stations located some dis- 
 tance apart, and also some distance away from the city. To ol)taiii 
 absolutely rehable data as to the difference in relative cost of furnishmg
 
 152 VALUE FOR RATE-MAKING 
 
 light and power, as between the present plant and a substitute steam 
 power plant, is a very difficult matter, there being a scarcity of data bear- 
 ing upon these points. While the facts we have succeeded in obtaining 
 indicate that the present plant may enjoy some advantages in this respect, 
 these advantages do not appear to be as great as expected, nor are they 
 as clearly established as they should be in order to furnish a safe basis 
 for the valuation of the water rights. 
 
 "In view of the facts thus presented with respect to the value of water 
 power rights, and in view of the further fact that this omission would not 
 seem to affect the conclusions in this case, no attempt is here made to 
 value the water power rights which are involved in this case. The 
 elements considered in the valuation of the physical property of the 
 plant include, of course, all improvements in connection with the water 
 power. "^ 
 
 In the Beloit case, the Wisconsin Commission says: 
 
 "Expert testimony has been introduced by both the city and the 
 company in regard to the value of the water power owned by the respond- 
 ent. The company claims that the value of the water power in question 
 is at the lowest estimate $150,000. The city's experts, on the other hand, 
 while conceding that a certain value attaches to this water power, will 
 not concede the lowest value claimed by the company, and would place 
 the value as between $27,167 (Fowle's report) and $50,000 (Evans' 
 report). The staff has submitted no estimate of the value of the water 
 power. 
 
 "It seems clear from the expressions of opinions thus made and from 
 the general practice of engineers and other men in valuing water powers 
 that the saving effected by the use of the water power over steam power, 
 especially, measures the value of the water power. Other methods of 
 appraisal are used and have been mentioned by the witnesses in these 
 proceedings, namely, rental value and market value. These latter 
 methods, however, are quite often open to objections which destroy 
 their reliability and it appears that it is almost always necessary to fall 
 back upon the method of calculating the saving over steam power and 
 then, by capitalizing this saving, arrive at the total value of the water 
 power. 
 
 "Referring further to the method of measuring the value of a water 
 right by the saving over steam power effected by the use of such power, it 
 is necessary to inquire closely into the relations between the water power 
 and steam power in the particular plant under consideration, for it is 
 obvious that where steam power is necessary as an auxiliary to the water 
 power, that the saving effected in such case cannot be measured by the 
 actual saving with the steam plant operating as an auxiliary. Such a 
 
 • 5 W. R. C. R. Ro3s et al. vs. Burkhardt Milling & Electric Power Co.. decided Apr. 8. 
 1910, page 146.
 
 LAND, PAVING, AND WATKh' h'iC/lTS i:,;i 
 
 method of calculating the saving and thus the vahie of tlie water right 
 would result in a larger value per horsepower for the imperfect watj-r 
 power than would be the case for a perfect or complete water ix)w<'r, 
 calling for no steam auxiliary. "^ 
 
 Nowhere in the decision is any fifrvnv given as ostahlishing a 
 value allowed for the water power, which apparently was imf cr.ti- 
 sidered in establishing the fair present value. 
 
 As will be seen from the preceding, the Wisconsin ( oimiiissiun 
 has indicated for several years a leaning toward the acceptance! 
 of the theory that the value of a water power could l)c dctcnnincd 
 from a consideration of the saving in the cost of an ecpiivalcnt 
 amount of energy produced in a steam plant or other coniparahh^ 
 source of power. In the recent case of the Rhinelandcr Tower 
 Company, where authority was sought to amend rates, the Com- 
 mission definitely fixed the value of the company's water power 
 from considerations of the saving in expenses resulting from the 
 water power as compared with "the next available source of 
 supply" a steam plant. After admitting that a theoretical saving 
 of $30,000 could be made for the hydraulic plant, the Commission 
 holds that to be strictly comparable with a steam plant, the 
 hydraulic plant would require an auxiliary steam plant ; the cost 
 of operating which, together with fixed charges, would amount to 
 $22,000, leaving an actual saving of " only about $8,000 per year." 
 After discussing some of the qualifying conditions of the case 
 and apparently capitalizing the net saving of $8,000 upon a 10 
 per cent, basis, the Commission concludes 
 
 •'with these facts in mind it appears that $80,000 is about a maximuin 
 value that could be fairly allowed for the water power rights under 
 present conditions. This amount added to the value of the physical 
 property, working capital and going value, bring the total valuation to 
 approximately $200,000. "^ 
 
 The New Hampshire Public Service Commission refused to 
 fully accept the theory that the value of water power could he 
 fixed by capitalizing its saving in the production of energy as 
 compared with the cost of fuel, saying: 
 
 "Water power has value, if it produces energy at a sufficient saving 
 over coal to offset the disadvantages attendant upon its variai)le pro- 
 
 1 7 W. R. C. R. City of Beloit vs. Beloit Water, Gas & Electric Co., July 19, 1911, paRc 
 187. 
 
 2 Decision of the R. R. Com. of Wiscousin, Jan. 30, 1915, in r^ application of the Rhino- 
 lander Power Co. for authority to establisli an amended schedule of rates, l-"> W. H. C. R. 800.
 
 154 VALUE FOR RATE-MAKING 
 
 duction. But the entire saving over coal, calculated on the total 
 annual production of power, and capitalized, certainly far exceeds the 
 value of the power — what one would pay for it as a substitute for a 
 steam plant. * * * 
 
 "One feature of the 'saving over coal' method of determining the 
 value of a water power should not escape attention. We live in a 
 region remote from the coal fields, the cost of transportation is heavy, 
 and the price of coal is higher than in almost any other part of the 
 country. On the other hand, ours is a mountainous State, with many 
 streams having a large fall and furnishing an abundance of water 
 power, much of which is still undeveloped. If we adopt the policy of 
 valuing water powers in rate and capitalization cases by capitalizing 
 their saving over coal, the people of the State are left subject to all the 
 disadvantages attendant on remoteness from the coal mines, while 
 enjoying no advantage from living in a region abundantly supplied 
 with water powers. A 'fair value' of a water power in New Hampshire 
 cannot be a value which takes no account of our natural resources, and 
 makes electricity produced by water as expensive to the public as if 
 produced by coal. * * * 
 
 "The evidence as to their value on a coal saving basis has been 
 given due consideration, but cannot be accepted as a final test of 
 value. "^ * * * 
 
 The Railroad Commission of the State of California has until 
 recently, consistently refused to recognize that utilities have any 
 property values in water rights. 
 
 In the recent case, No. 1370, of the Eureka Water Company, 
 where this Commission was fixing the compensation to be paid 
 by the city, the company computed the value of its water rights 
 on two bases, the additional cost that would be incurred by bring- 
 ing the next available source of water into Eureka and an arbi- 
 trary price per million gallons supplied, each basis resulting in a 
 value of $100,000. While omitting a discussion of the propriety 
 of a value of water rights, the Commission rejects the theory of 
 the next available supply as absolutely untenable as determining 
 the value of the existing supply or for any purpose whatsoever, 
 stating that such cost has no reference to the value of any right 
 to take water from the existing source of supply. Similar con- 
 clusions, as to the absence of value in water rights, were held in the 
 Northern California Power Company case decided July 13, 1913, 
 and others. These rulings of the California Commission are of 
 particular interest because the Supreme Court of the United 
 
 ' Petition of Grafton Electric laght & Power Co., decided Feb. 3, 1914, by New Hmapshire 
 Public Service Coiumission.
 
 LAND, PAVING, AND WATER mmiTS i-jo 
 
 States has recently decided in the case of a Cahfornia corporation 
 that even for rate-making purposes the value of water rights must 
 be determined and included as a part of the property upon wliidi 
 returns are to be allowed. This decision being supreme and 
 final will probably henceforth compel recognition of, and allow- 
 ance for water rights as a part of the property which must Ix- 
 valued, where title to, or control of such belongs to the utiHty 
 being regulated. 
 
 The decision referred to was handed down Apr. 27, 1911, and 
 is so illuminating, and of such importance as to warrant rather 
 full explanation and quotation. 
 
 The ruling was made in the suit of the San Joaquin & Kings 
 River Canal & Irrigation Co., against the County of Stanislaus et 
 al. to restrain the enforcement of orders of the Boards of Super- 
 visors of Stanislaus, Fresno and Merced Counties, fixing rates 
 allowing a 6 per cent, return on tangible property, but giving no 
 consideration to the water rights claimed by the appellant. 
 
 The Supreme Court confined its opinion solely to the question 
 of whether water rights should be given consideration in evalu- 
 ating property for rate-making purposes. The defendants 
 refused to make such allowance, and in this position they were 
 sustained by the Circuit Court, 191 Fed. Rep. 875. The United 
 States Supreme Court said: 
 
 "The bill (to restrain the enforcement of orders passed by the Boards 
 of Supervisors of the three defendant Counties, Stanislaus, Fresno & 
 Merced, establishing water rates to be charged by the plaintiff) concerns 
 rates fixed in 1907 and the question before the court has been narrowed 
 to a single issue. If the plaintiff is entitled to 6 per cent, upon its 
 tangible property alone, it is agreed that the orders must stand. But 
 if the plaintifif has water rights that are to be taken into account, the 
 rates fixed will fall short of giving it what it is entitled to and must be 
 set aside. * * * The Circuit Court dismissed the bill, 191 Fed. Rep. 
 875 and on this appeal figures are immaterial, the only question being 
 whether the principle adopted is right. 
 
 "It is not disputed that the plaintiff has a right as against riparian 
 proprietors to withdraw the water that it distributes through its canals. 
 Whether the right was paid for, as the plaintiff says, or not, it has been 
 confirmed by perscription and is now beyond attack. It is not ths- 
 puted either that if the plaintiff were the owner of riparian lands of which 
 its water was distributed, it would have a property in the water that 
 could not be taken without compensation. But it is said that as the 
 plaintiff appropriates this water to distribution and sale, it thereby
 
 156 VALUE FOR RATE-MAKING 
 
 dedicates it to public use under California law and so loses its private 
 right in the same. It appears to us that when the cases cited for this 
 proposition are pressed to the conclusion reached in the present case, 
 they are misapplied. No doubt it is true that such an appropriation 
 and use of the water entitles those within reach of it to demand the use 
 of a reasonable share on payment. It well may be true that if the waters 
 were taken for a superior use by eminent domain those whose lands 
 were irrigated would be compensated for the loss. But even if the rate 
 paid is not to be determined as upon a purchase of water from the plain- 
 tiff, still, at the lowest, the plaintiff has the sole right to furnish this 
 water, the owner of the irrigation lands cannot get it except through the 
 plaintiff's help, and it would be unjust not to take that fact into account 
 in fixing the rates. We are not called upon to decide what the rate shall 
 be, or even the principle by which it shall be measured. But it is 
 proper to add a few words. 
 
 "The declaration in the Constitution of 1879 that water appropriated 
 for sale is appropriated to a public use must be taken according to its 
 subject matter. The use is not by the pubHc at large, like that of the 
 ocean for sailing, but by certain individuals for their private benefit 
 respectively. Thayer vs. Cal. Development Co., 164 Cal. 117, 128 — 
 Fallbrook Irrigation District vs. Bradley, 164 U. S. 112, 161. The 
 declaration, therefore, does not necessarily mean more than that the 
 few within reach of the supply may demand it for a reasonable price. 
 The roadbed of a railroad is devoted to a public use in a stricter sense, 
 j^et the title of the railroad remains, and the use though it may be 
 demanded, must be paid for. In this case it is said that a part of the 
 water was appropriated before the Constitution went into effect, and 
 that a suit now is pending to condemn more as against a riparian pro- 
 prietor, for which, of course, the plaintiff must pay. It seems unrea- 
 sonable to suppose that the Constitution means that if a party instead of 
 using the water on his own land, as he may, sees fit to distribute it to 
 others he loses the rights that he has bought or lawfully acquired. 
 Recurring to the fact that in every instance only a few specified indi- 
 viduals get the right to a supply, and that it clearly appears from the 
 latest statement of the Supreme Court of California, Palmer vs. Rail- 
 road Commission, Jan. 20, 1914, 47 Cal. Dec. 201, that the water when 
 appropriated is private property, it is unreasonable to suppose that the 
 constitutional declaration meant to compel a gift from the former owner 
 to the users and that in dealing with water appropriated for sale it 
 meant that there should be nothing to sell. See San Diego Water Co. 
 vs. San Diego, 118 Cal. 556, 567 — Fresno Canal & Irrigation Co. vs. 
 Park, 129 Cal. 437, 443, et seq. Stanislaus Water Co. vs. Bachman, 
 152 Cal. 716, Leavitt vs. Lassen Irrigation Co., 157 Cal. 82. Decree 
 reversed."^ 
 
 ' 233 U. S. 459.
 
 CHAPTER VII 
 
 FRANCHISES, WORKING CAPITAL AND BOND 
 DISCOUNTS 
 
 Franchises. — Almost without exception the State puhlic 
 utiUty commissions have held, and the various courts have 
 frequently ruled, that a public utility corporation has no right 
 to capitalize its franchise, particularly for rate-makinp;. Tiiis 
 ruling has been the same whether the franchise is exclusive, 
 perpetual, limited to a definite term of years, or of the "in- 
 determinate" type. The usual argument for the justification 
 of such ruling is, that the public, having granted the franchise, 
 should not be compelled to pay a return thereon. The conclusion, 
 however, is not entirely warranted. There can be no question 
 but what the rights that may have been granted under a franchise 
 were once owned by the public but they were parted with for a 
 particular purpose and in consideration of the carrying out of 
 certain obligations, which, as long as fulfilled binds the grantor. 
 As a rule, the utilities have omitted to make any claim for value 
 of franchise in the same way that going value has not been 
 claimed in many instances. This omission of claim for value has 
 been perhaps an error, as it may well be argued that a franchise 
 which was given some years ago, as an absolute conveyance, as 
 an inducement to the investment of capital, and the development 
 of a public utility should have its value recognized and return 
 thereon allowed the same as any other donation. Years ago, 
 when the Federal Government was anxious to have transcon- 
 tinental railroads built to the Pacific Coast, it gave outright 
 thousands of acres of land adjacent to, and in addition to, the 
 right-of-way, in order to induce the investment of the necessary 
 capital to build the railroads. This land never cost anything 
 more than most franchises have in the past. The Supreme Court 
 has repeatedly and distinctly held that railroads have unques- 
 tionable title to the land received as a donation from the govern- 
 ment, and that they are justified in demanding returns on its 
 full present value. Not many months ago the Supreme Court 
 
 157
 
 158 VALUE FOR RATE-MAKING 
 
 decided in favor of the Southern Pacific Railway against claim- 
 ants to mineral lands, worth approximately $700,000,000, 
 which had originally been given to the railroad by the Govern- 
 ment. Reference has already been made, on page 47, to the 
 recent decision of the Supreme Court in confirming the cor- 
 poration's title to land given by the Government under the 
 Oregon and California Railroad Land Grant. It would seem no 
 less fair or logical to recognize the value of franchises granted 
 by the public without cost — admitting the difficulty of fixing the 
 fair value — than to allow the value of donated real estate. This 
 view has been sustained in certain instances, notably in the Con- 
 solidated Gas Company case where the Court, sustaining an 
 allowance of $7,781,000 as the value of a franchise, said: 
 
 "It cannot be disputed that franchises of this nature are property and 
 cannot be taken and used by others without compensation."^ 
 
 In the Kennebec Water District case, the Court stated: 
 
 "The defendants' request 11 should be given in this case. It has 
 been given in part already. It is that the value of a franchise depends 
 upon its net earning power, present and prospective, developed and 
 capable of development, at reasonable rates, that the value to be assessed 
 is the value to the seller and not to the buyer, and that 'just compensa- 
 tion' means full compensation for everything or element of value taken. 
 Monongahela Nav. Co. vs. United States, swpra. The appraisal must 
 be made, having in mind what we have already said, concerning the char- 
 acter and duration of the franchises and the reasonableness of rates. 
 While with these limitations, the owner is entitled to receive the value 
 of the franchises, having reference to their prospective use as now de- 
 veloped, and to the future development of their use, consideration must 
 also be had of the fact that further investment may be necessary to 
 develop the use, and of the further fact that at any stage of development 
 the owner of the franchise will be entitled to charge only reasonable 
 rates under the conditions then existing. But, subject to such limita- 
 tions, we think it should be said that the owner is entitled to any appre- 
 ciation due to natural causes, such as, for instance, the growth of the 
 cities or towns in which the plant is situated. Cotting vs. Kansas City 
 Stock Yards Co., 82 Fed. Rep., 850."^ 
 
 In the Monongahela Navigation Company case above referred 
 to, Congress had passed an Act providing for the condemnation 
 
 ' Wilcox vs. Consolidated Gas Co., 212 U. S. 44. 
 
 ^ Kennebec Water District vs. Waterville, 97 Me. 18o.
 
 FRANCHISES, WORKING ('API TAL, DISCO ( W TS l .V.i 
 
 of the property of the Navigation Company, and spcci Ileal ly 
 provided that no compensation should be paid for the franchise 
 right to take tolls. The Supreme Court held that this provision 
 as to franchise right was in violation of the Fifth Amendmcnl of 
 the Constitution, saying: 
 
 "So, before this property can be taken away from its owners, llie 
 whole value must be paid; and that value depends largely upon the pro- 
 ductiveness of the property, the franchise to take tolls. 
 
 "The franchise is a vested right. The State has power to grant it. 
 it may retake it, as it may take other private property, for puljjic uses, 
 upon the payment of just compensation. A like, though a superior, 
 power exists in the national government. It may take it for i)ublic 
 purposes, and take it even against the will of the State; but it can no 
 more take the franchise which the State has given than it can any pri- 
 vate property belonging to an individual."^ 
 
 In the Spring Valley Water Company case, the Court said: 
 
 "That a franchise is property has been declared by the Constitution 
 and affirmed repeatedly by the Supreme Court of the State of Cali- 
 fornia."^ 
 
 The Railroad Commission of Wisconsin has recently said, 
 in fixing the value of corporation property to be purchased 
 by a municipality: 
 
 "Even if the city could lawfully condemn the franchise of the com- 
 pany, it would not be benefited thereby to any material extent. .Vs 
 the franchise is essential to the operation of the property, any damage 
 for taking such franchise, separate and apart from the property, would, 
 under any valid law, result in requiring the municipality to pay the 
 difference in the value of the property, including the franchise before 
 and after the taking of the franchise."^ 
 
 "It is suggested in the opinion by Commissioner Shaughnessy that, 
 as a rule, the courts have held that franchises have no value for rate- 
 making purposes. But he says that the case of Willcox vs. Consolidated 
 Gas Company, in the 212 U. S. 19, is an exception to the rule. So far 
 from such being the case, as I have read the authorities, the Willcox 
 case in the 212 U. S. supra, is not an exception to the rule, but states 
 the rule. And, what is of the first importance in this case, it is a rule 
 established by the highest tribunal in this country, viz., the Supreme 
 Court of the United States. 
 
 • Monongahela Navigation Co. vs. U. S. 148, U. S. 329, 341. 
 
 ^ Spring Valley Water Company vs. San Francisco, 165 Fed. 607. 
 
 ^ Neenah vs. Wisconsin TracUou Light, Heat «fc Power Co., P. U. U. 1913. A, 372.
 
 160 VALUE FOR RATE-MAKING 
 
 "In the case of Willcox vs. Consolidated Gas Company the Court dis- 
 tinctly recognized the fact that the franchise was property and that it 
 had a value to be considered for purposes of rate-making. All that the 
 Court said which points toward sustaining my associate's contention, 
 is that there was no evidence in the case that justified the lower court, 
 in allowing an increased valuation for the franchise over and above that 
 which has been given to it at an earlier date. The increased valuation, 
 from more than seven millions of dollars to twelve millions of dollars, 
 was based simply upon the reasoning of the court below that the value of 
 the franchise should increase pro rata with the increase of the business. 
 This, though, was rejected by the Supreme Court, and, as I think, 
 properly. 
 
 "If we turn to page 44 of the volume mentioned, we find tliis 
 language: 
 
 "It cannot be disputed that franchises of this nature are property, 
 and cannot be taken or used by others, without compensation. (Citing 
 Monongahela Company vs. United States, 148 U. S. 312; people vs. 
 O'Brien, 111 N. Y. L. and cases cited). The important question is 
 always one of value. 
 
 "From the foregoing, it will be seen that the Supreme Court of the 
 United States had previously decided the same question the same way 
 and that the highest court in the great State of New York, a court 
 second in dignity only to that of the Supreme Court of the United 
 States, had done the same."^ 
 
 A series of important decisions in the matter of franchise 
 value have recently been handed down by the New Jersey Courts. 
 The Board of Utility Commissioners of New Jersey, in fixing the 
 rates in the Passaic District, for the Public Service Gas Company, 
 allowed 30 per cent, of the value assigned to the structural plant 
 to cover the value of the intangible property. As the Com- 
 missioners expressly stated, the allowance included everything 
 outside the tangible property, also: "the entire value of all 
 franchises primarily or secondarily, possessed or exercised by the 
 Company in the Passaic Division." The Corporation appealed 
 from the decision of the Commissioners, holding that no proper 
 recognition of and allowances for franchise had been made in the 
 value fixed for the company's property. The case was passed 
 on by the Supreme Court of New Jersey, which, after review- 
 ing the law in the case, stated: 
 
 1 Public Service Commission of Nevada vs. The Nevada-California Power Company, 
 decided .Tan. 20, 1914.
 
 FRANCHISES, WORKING (WriTAL, DTSroiXTS ic.i 
 
 "Logically, no allowance should be made tor the value of the special 
 franchise in a case where it is not legally exclusive and where the St, -if i- 
 still retains the right to fix rates."' 
 
 The Corporation, not satisfied with this decision of t lie Suiircinc 
 Court, appealed to the New Jersey Court of Errors and Api>cals, 
 which Court, after first rendering; a decision in Dcceinhor, 1914, in 
 which it said: "We find ourselves unable to concur in this 
 result," reversed the Supreme Court; later, in .liinc, I!)!."), after 
 rehearing upon further appeal the same Court reversed its own 
 previous decision and sustained the decision of the Supreme 
 Court. The Court, speaking through Judge White, rendered 
 an important opinion from which the following passage is well 
 worth repeating here: 
 
 "Taking up the second proportion, that the company's charter right 
 to charge reasonable rates is in itself a valuable property right entitled 
 to consideration in rate-making, I suppose it must be conceded that 
 the franchise to charge as a 'reasonable rate,' sufficient to yield a net 
 profit of 8 per cent, on the value of the company's property, as allowed 
 and established respectively by the findings of the Utilities Commission 
 in this case, is a very valuable property right. Certainly I think it 
 is. That this valuable privilege is the company's is beyond question. 
 That it is property is undoubted. That the law protects it against con- 
 fiscation and subjects it to taxation follows as a matter of course." 
 
 "But that this valuable property right to charge 'reasonable rates' 
 should by virtue of its own existence have the effect of converting itself 
 into a still more valuable property right to charge 'unreasonable rates' 
 is, of course, preposterous. Presumably the incorporators went into 
 this public-utility business because they expected that their charter 
 privilege to charge 'reasonable rates' for the gas they were to manu- 
 facture, distribute and sell would be a valuable one, but that fact and 
 the fact that it has become so cannot have the effect of altering the 
 terms of the contract made with the State ..." 
 
 The Court then discusses the basis of reasonable rates and 
 concludes with the statement that: 
 
 "The plain fact is that the commercial value of the company's prop- 
 erty right in its franchise can have no effect in fixing the rate it can charge, 
 because by the terms of its contract with the State the stream of its 
 franchise value arises from the spring of its right to charge 'reasonable 
 
 ' 84 N. J. L. 482. 
 11
 
 162 VALUE FOR RATE-MAKING 
 
 rates,' and in the very nature of things no stream can rise higher than 
 its source."^ 
 
 Under the regime that has heretofore existed, the franchises 
 granted pubHc utihty corporations will be found to have greater 
 or less value because being perpetual, or having a definite term 
 of life, unless there is a contract stipulation that the rights 
 given thereunder should be without value as against the donor. 
 Consequently, some value perhaps merely nominal, or an 
 estimated amount commensurate with the value may be recog- 
 nized in the appraisal of utility property. 
 
 Even when the fact is clearly recognized and admitted, 
 that a franchise is a contract between the pubhc and the utility, 
 and has value, the determination of the value of the franchise is 
 not easy. In case a definite value of franchise has been recog- 
 nized by proper public authorities, as in the case of the Consoli- 
 dated Gas Company, or in case definite payments have been made 
 in order to secure a franchise, the value for rate-making is easily 
 fixed. In cases where public authorities are now granting 
 franchises on the basis of some uniform charge the value of an 
 equivalent franchise, free of any charge burdens, could be 
 valued upon the basis of capitalizing the net savings. It is self- 
 evident that the franchise value for rate-making purposes 
 cannot be properly and equitably obtained by capitalizing net 
 earnings, although such method is applicable where rates are rea- 
 sonable or the determination of value is necessary for purchase 
 and sale. For the latter purpose the accounting process is to 
 determine the present worth of future net earnings on the basis 
 of carrying out of franchise obligations and maintenance of the 
 utility property. The determination must, of course, take into 
 account the annual operations of the utility throughout the 
 successive remaining years of the life of the franchise. Where a 
 utility is charged for its franchise by the public authorities, the 
 entire cost of the franchise is borne by the consumers, whether 
 it is amortized during the life of the franchise or treated as a 
 permanent investment entitled to a fair return; hence a franchise 
 charge is merely an indirect collection of taxes. 
 
 A very excellent summary of the effect of charges being made 
 for the granting of franchises has been given by the Wisconsin 
 Railroad Commission in one of its earliest cases. 
 
 > Public Service Gas Co. vs. Board of Public Utility Commissioners, 94 Atl. 634.
 
 FRANCHISES, WORKING CAPITAL, DISCOUNTS 103 
 
 "Franchises are not always obtained without cost. Many of tlicrii 
 include provisions which entail outlays that may be charged either to the 
 capital account or the operating expenses. The former may consist of 
 considerations in the form of stipulated payments to the municipality, 
 license fees, a certain amount of free service upon which values can be 
 placed, and other items of this character. The latter may include the 
 upkeep of streets and other property, extra services of various kinds, 
 and other items of a similar nature. The former, again, would secni to 
 be as much a part of the investment in the plant and in its business as 
 the cost of the physical plant, and there would appear to be the best of 
 reasons why such costs should be included in the value of the plant for 
 rate-making purposes. The latter would also appear to be legitimate 
 charges to the operating expenses. In fact, we can see no valid reason 
 to the contrary. Both would seem to be just charges against the con- 
 sumers. Both tend to increase the expenses, and consequently the 
 rates, and these increases would seem to be fair and equitable to all 
 concerned."^ 
 
 In the case of a perpetual franchise, or "indeterminate" 
 permit, no annual expense or charge to provide a fund to amortize 
 the value of the property is necessary for inclusion in the items 
 going to make up the sum total of operating charges to be borne 
 by the public. On the other hand, where a franchise is limited 
 to a definite term of years, the value of the property, less scrap 
 value, must be amortized during the life of the franchise, thereby 
 increasing the annual charge on the customers; the greater, the 
 shorter the hfe of the franchise. This principle has been authori- 
 tatively recognized in the decision of the Pubhc Service Com- 
 mission of New York, Second District, in the Cataract Power 
 and Conduit Company case, where the Commission says: 
 
 "The subject of general amortization has been necessarily discussed 
 somewhat fully under the head of depreciation, of which it is essentially 
 a part. It appears from that discussion that the company has been 
 handling its amortization upon the theory that the term of life to be 
 reckoned with was the term of its franchise, which expires Jan. 14, 1912. 
 It has collected a large sum of money from the public upon that theory, 
 which sum, if properly invested, will amount at the end of the term to 
 upward of $1,000,000. It may also be assumed that the company has 
 practically proceeded upon the theory of a sinking fund invested m 
 outside securities. In fact, a very considerable amount is actually 
 thus invested. * * * Since practically the company should be 
 allowed to earn returns upon the investment value of all its property in 
 
 1 Hill vs. Antigo Water Co., 3 W. R. C. R. 023.
 
 164 VALUE FOR RATE-MAKING 
 
 the public service irrespective of the source from which tlie money was 
 derived, we are compelled to adhere to the theory of the sinking fund 
 invested in outside securities. 
 
 "Deducting from the total investment value of the property in ser- 
 vice the value of the land as non-depreciable, the working capital, the 
 materials and supplies, and making proper allowance for scrap value of 
 the depreciable property, the Commission finds that the total depre- 
 ciable property amounts to $1,760,663. The sinking fund already pro- 
 vided will take care of $1,065,968 of this. Hence there is depreciable 
 property to the amount of $694,695 which should be amortized during 
 the 20 years of the franchise term remaining unexpired Jan. 14, 1912." 
 
 "It may be observed, however, that the amount which is to be amor- 
 tized of the present capital of the company, both tangible and intangible, 
 after making all suitable deductions for scrap values and property which 
 is not subject to amortization, amounts to $1,760,663, leaving a net 
 amount to be provided for of $694,695, which would require an annual 
 payment into the sinking fund of $23,342."^ 
 
 Capitalization of franchise, aside from actual expenditures 
 required by the public regulating body granting such franchise, 
 has no proper warrant in an ideal system of public utility control 
 and regulation. Exercising the right to regulate rates, the rate- 
 fixing body must take into consideration and include as a part of 
 operating expenses, to be paid by the public for the service 
 rendered, any addition to the operating cost incurred by taxes 
 that may be imposed by the public, either in the way of a fair 
 return to be allowed on the capital invested in the original 
 purchase price of a franchise, or as a toll, or levy on earnings 
 or property. There is nothing in such tax that tends to improve 
 service, or reduce rates; in fact, the exact contrary is more 
 hkely to result because operating expenses must embrace all fair 
 and reasonable costs including taxes which thus become a further 
 burden on the users of the utility service. Taxing a public 
 utility is merely an indirect method of having its customers 
 contribute to the public purse without thoroughly understanding 
 and appreciating the fact that they are not getting minimum 
 rates for service rendered. There is no sound logical or economic 
 reason for compelling a public utility to include tolls or taxes, in 
 its annual operating expenses. 
 
 The relations between the owners of a public utility property, 
 operating a limited franchise, and the public are similar to that 
 
 ' Public Service Commission, State of New York, Second District, Louis P. Fuhrmann 
 vs. The Cataract Power & Conduit Company, Decided Apr. 2, 1913, pages 71-9.
 
 FRANCHISES, WORKING CAPITAL, DISCOUNTS icr, 
 
 of a capitalist who advances money under a mortKUKe on im- 
 proved real estate. Not only must the owner charge rents 
 sufficient to pay the interest on the money loaned, he must charge 
 sufficient to provide funds necessary to operate tlic huilding, 
 furnishing elevator service, cleaning, decorating, and regiilMr 
 repairs, but he must also charge an amount to provide a sinking 
 fund that will pay off the mortgage when due. It is a mistaken 
 idea in the case of public service utilities, too connnonly known, 
 that, when the public has paid operating expenses and a return 
 upon the theoretically depreciated value of the property, it has 
 fulfilled its full obhgation to the investor, whereas the latter is 
 entitled as a rule to receive from the public not only a return on 
 the undepreciated value of his property throughout the entire 
 period of its service, but, in addition, the full value of that 
 property which is worn-out and becomes worthless in the service 
 of the public, in order that both the return upon the investment 
 and the investment itself may be received by the owner. 
 
 Working Capital. — The term "working capital" is usually 
 taken to include that part of the capital investment of a Public 
 Utility Corporation represented by: 
 
 First. — Necessary cash on hand and in banks. 
 
 Second. — The value of materials, stores and supplies in stock 
 necessary for the normal conduct of the business. 
 
 The above limited use of the term working capital does not 
 properly cover and include all of those quick assets which should 
 be recognized and allowed in determining the fair value of work- 
 ing capital required by the ordinary, going utility. 
 
 In addition to the elements enumerated above, there should 
 be considered and included accounts receivable and the accounts 
 payable, as well as the value of other assets, such as prepayments, 
 stocks on hand, or possibly even credits, by which the conduct 
 of the business may be facilitated and its cost minimized. 
 
 In cases of purchase and sale, the cash on hand or in banks is 
 not ordinarily transferred with title to the property. On the 
 other hand, the present value of stores and supplies, the dif- 
 ference between accounts receivable and accounts payable, 
 accrued interest, wages, taxes and prepayments, are all usually 
 considered and equitably adjusted in the price paid by the 
 purchaser. 
 
 It is generally conceded by authorities in public service regu- 
 lation that the question with regard to working capital is not
 
 166 VALUE FOR RATE-MAKING 
 
 whether any working capital should be provided as a part of the 
 capital cost, but rather the amount of working capital to be 
 properly allowed in the sum representing the total fair value of 
 the property used and useful. 
 
 The amount of working capital will vary with the character 
 of the business of the corporation being considered. With 
 street railways, for example, where the fare is paid by the pas- 
 senger in advance of the service to be rendered, the amount of 
 cash working capital required by such utility will be very much 
 less than in the case of a water- works corporation, which sends 
 out bills only once in three or six months and receives its payment 
 from four to eight months after rendition of service. 
 
 The cash on hand at any particular period, or the average of 
 different periods, may not fairly indicate the cash quickly avail- 
 able for a utility, because other quick assets or individual credit 
 may permit the drawing down of cash actually on hand to a 
 minimum. In a similar way, the value of stores and supplies 
 found to be on hand at any particular time may not be a fair 
 indication of the amount to be allowed for this purpose. In the 
 case of any particular utility being considered, regard must be 
 given as to the distance from which stores and supplies are prin- 
 cipally shipped, the time required for filling orders by the manu- 
 facturers after placing, the tardiness of transportation, due to 
 distance or congestion; these matters all bear on the question of 
 proper allowance of the quantities and hence the amount of 
 capital equitably necessary for stores and supplies. 
 
 In determining the value of a utility, whether for rate-making 
 or sale, consideration of all of the elements fairly constituting 
 working capital should be ascertained and included or excluded, 
 as the circumstances may warrant. These elements may fairly 
 be divided as follows: 
 Current Assets: 
 
 Cash. 
 
 Stores and supplies. 
 
 Manufactured product on hand. 
 
 Manufactured product dehvered to customers but not billed. 
 
 Accounts receivable. 
 
 Prepayments of insurance, taxes or other normal operating expenses. 
 Current Liabilities: 
 
 Accounts payable. 
 
 Interest accrued. 
 
 Wages accrued. 
 
 Taxes or insurance accrued.
 
 FRANCHISES, WORKING CAPITAL, DISCOUNTS ic: 
 
 Criticism of the acceptance, as working capital, of the excess of 
 current assets over current Kabilities has been made on the jthmumI 
 that such assets include at certain times cash held for invcsttncnt, 
 interest, dividends or taxes, which would thereby artificially in- 
 crease the real working capital. Of course, this criticism is jusf in 
 proportion to the amounts of cash regularly held in the bank for 
 investment in plant additions but such criticism further assumes 
 that interest, dividends and taxes are always wholly accumulated 
 in cash before being paid out, which is not necessarily a fact. 
 Working capital must be sufficient to provide funds for the pur- 
 chase of repair parts and maintenance, as well as all other oper- 
 ating expenses, also such proportion of the interest, dividends, 
 taxes and like expenses, which must be paid regularly, even 
 though they may not yet have been paid in, though accrued, and 
 in other instances where there is a temporary loss of revenue due 
 to financial embarrassment or panic, strikes of labor or other 
 abnormal conditions. Very frequently public utility corporations 
 are not able to wholly accumulate interest payments in advance. 
 In all considerations of the amount of working capital to be 
 allowed any utility, liberality should be used, because the public 
 is only called upon to pay a return on the amount allowed, and a 
 very small difference in this respect would make a large difference 
 in the credit, standing and financial ability of the utility, and in 
 most instances would many times compensate the public for 
 the small difference in return it would be called upon to pay 
 between a niggardly or a liberal allowance for working capital. 
 It is generally recognized that the working capital of a corpo- 
 ration doing a small business must be relatively large compared 
 with the amount of working capital required by a corporation 
 doing a large business, because in the case of the latter in- 
 equalities in receipts and expenditures tend to equalize and 
 smooth themselves out, due to the very much greater number of 
 transactions. 
 
 In order that a utility may be enabled to carry on its business 
 with the maximum economy, resulting from advantageous buy- 
 ing and discounting of bills, there must be available, both the 
 highest credit and sufficient cash on hand to take advantage 
 of discounts. It may be argued that it is not necessary to pay 
 for supplies as soon as delivered, because 30 or 60 days credit is 
 obtainable. Again, it is claimed a utility with reasonable 
 credit may borrow from time to time to provide for current
 
 168 VALUE FOR RATE-MAKING 
 
 needs. The answer to the first argument is that a discount 
 is usually obtainable for prompt payment as the seller must, 
 of necessity, include the interest charge in his selling price if 
 compelled to carry an account for 30 or 60 or 90 days. In reply 
 to the second argument, borrowing of course requires the paying 
 of interest on loans, which results in a higher operating cost to 
 the utility and increases the rates for service rendered; conse- 
 quently a fairly definite amount of cash on hand should always be 
 held as liquid capital by every properly managed efficient public 
 utility. 
 
 To render efficient service a utility must always have on hand 
 and available an ample quantity of stores and supplies with 
 which to make repairs or replacements that are ordinarily de- 
 manded at a fairly uniform rate, but which must be available in 
 sufficient quantity at all times to provide for unexpected or 
 sudden, unusual and exceptional demands. In order to manu- 
 facture or provide the commodity which is later sold to its 
 customers, the utility must purchase and furnish in advance 
 of consumption, sometimes for long periods previous to con- 
 sumption, such items as fuel, oil, labor, etc. Consequently, in 
 addition to cash on hand or in bank, there must be always con- 
 veniently available or in storerooms a quantity of stores, sup- 
 plies, repair and renewal parts, as well as fuel, oil or other raw 
 material required by the manufacturing processes that repre- 
 sent a proportion of the capital investment of a properly managed 
 public utility. 
 
 In addition to stores and supplies on hand, the value of product 
 manufactured or delivered, but not yet billed, such as gas in a 
 holder or electrical energy delivered to consumers in advance 
 of the monthly billing, may fairly be included. The value of 
 these products, which often represent a substantial part of the 
 capital of a utility tied up and invested in the business, has 
 frequently been overlooked or ignored in fixing the proper basis 
 for rate-making. It will be recognized that the books do not 
 show the value of such product as has been manufactured, or 
 possibly sold and delivered, until the bills against the consumers 
 are made out, although the cost of manufacture has accrued 
 against the company. Where bills are made out at frequent 
 intervals the value of the product may not run into very large 
 amounts, but where bills are rendered semi-annually, for example 
 in the case of water-works, the value of the manufactured or
 
 FRANCHISES, WORKING CAPITAL, DISC()(J\TS \m 
 
 delivered product may prove to be a very coiisidcraMc portion 
 of the total value of the property. 
 
 Under the generally accepted terms and methods of doinj^ 
 business, goods and materials received are not paid for upon 
 delivery, with the result that bills and accounts receivable and 
 bills and accounts payable largely tend to offset one another, but 
 their difference either as a credit or debit may be taken into 
 account in ascertaining the proper and necessary working capital 
 of utility. 
 
 It is frequently the case that the control of a public utility is 
 held by a holding or controlling company through stock owner- 
 ship. In such cases it is not uncommon practice for the holding 
 company to have turned over to it at frequent intervals, perhaps 
 monthly, practically all revenues received by the subsidiary 
 corporation, then all bills for supplies, equipment, salaries, 
 interest and other large items are paid by the holding company, 
 the subsidiary corporations merely keeping small amounts of 
 cash on hand with which to pay local, current bills. Under these 
 conditions the holding company, and not the local corporations, 
 as a matter of fact, requires the bulk of the working capital 
 necessary to conduct the operations of the subsidiary cor- 
 porations; hence the quick assets and cash on hand of the 
 latter do not indicate the amounts required for the proper 
 conduct of their business, because in such cases the cash, quick 
 assets and credit of the holding company are used for the benefit 
 of the subsidiary companies. In determining the proper amount 
 of working capital that should be allowed a subsidiary company, 
 controlled in the manner indicated, this credit of the suV)sidiary 
 company with the holding company is usually equivalent in 
 value to quick assets or cash actually on hand. This arrange- 
 ment and credit of the subsidiary company with the holding 
 company, together with the cash or other quick assets held locally 
 by the former, the value of the stores and supplies on hand, 
 both locally and at the distributing center, controlled by the 
 holding company and held available for the benefit of the 
 subsidiary company, together constitute the working capital of 
 the subsidiary company. A fair method of ascertaining the 
 total value of the stores and supplies, cash on hand and quick 
 assets that may normally be allowed the subsidiary company, 
 existing under such arrangements and controlled as outlined 
 above, may be measured by the methods suggested as proper
 
 170 VALUE FOR RATE-MAKING 
 
 for determining the working capital of a utility entirely locally 
 controlled. 
 
 Various methods have been suggested for determining the 
 proper amount of working capital required for the different classes 
 of utilities under normal or average conditions. A very generally 
 accepted basis of estimate is to fix the amount of cash working 
 capital from a consideration of the annual gross revenues. This 
 basis has been frequently accepted by courts and commissions as 
 reasonable, because related to the amount of business being 
 transacted and dependent, in a large measure, upon those re- 
 ceipts and their usually attendant expenses. Varying percentages 
 of the annual gross revenue have been used for determining cash 
 working capital, varying from 5 per cent, to 25 per cent, depend- 
 ing upon the character of the business and the size and credit of 
 the corporation. An examination of the cash balances kept on 
 hand by a number of public utilities of different classes, such as 
 gas, electric light and street railway property, averaged over a 
 large number of months, aggregating several years, shows that 
 practically 121^ per cent, of gross revenue was maintained as 
 the actual cash working capital on hand. This figure would, 
 therefore, seem to have considerable weight as showing the normal 
 average condition and the average requirements of such utility. 
 
 A second method of determining the normal amount of cash 
 working capital required by a public utility, which is receiving 
 much consideration, is based on an examination of the monthly 
 and annual operating expenses and payments, as well as the con- 
 ditions under which receipts from the sale of the service rendered 
 by the utility, are received from its customers, by the corporation. 
 It will be seen where receipts do not come in for 15 days, for ex- 
 ample, after the expiration of the period to which such receipts 
 relate, and the bills upon which such receipts are based are 
 rendered the first of the month for service performed during 
 the preceding month, the current liabilities of the corporation 
 being largely incurred before the service is rendered, the payment 
 of which liabilities under the wisest business management should 
 not and cannot be deferred, there probably should be provided 
 and available sufficient cash working capital to meet two months' 
 average payments. When bills are not rendered monthly but 
 over longer periods, still larger amounts of cash working capital 
 must be provided than would be indicated by a two months' aver- 
 ago payment of expenses. Moreover, an amount larger than that
 
 FRANCHISES, WORKING CAPITAL, DISCOUNTS 171 
 
 Table V. — Woukin*; ('aimt.m, 
 Public Service Commission Decision, Working (',i])it:il Ailowanct^ 
 
 i 
 Revenue Op. exps. 
 
 1 
 
 Net 
 
 Repro. val. 
 
 i 
 Working cap. 
 
 ■ Per r< 
 Rev. 
 
 III. of 
 
 1 val. 
 
 Wisconsin : 
 
 Madison G / G 
 & E Co. IE 
 
 Beloit W. G. & 
 
 $ 
 
 141,272 
 199,892 
 
 181,f)61 
 
 1 
 
 1 
 « 
 
 82,615 
 100,293 
 
 97,435 
 
 $ 
 58,6.57 
 99,599 
 
 83,120 
 
 412,000 
 535,000 
 
 (45 ,"i0,000; 
 
 (suppl. 
 
 $.30,000) 
 
 45-45,000 
 
 ('/^ cash-?i 
 
 suppl.) 
 
 914,948 
 (484,578 cash) 
 
 854,2.^.2 
 1 766,008 
 
 40,000 
 
 (half cash 
 
 and half 
 
 suppl ) 
 
 80.000 
 
 (half cash 
 
 and half 
 
 suppl.) 
 
 .30,000 
 
 45,000 
 
 45,032 
 
 100,000 
 
 Cash 100,000 
 M.&S. 5 1,037 
 Cash 80,0(X) 
 M.&S. 40, 180 
 Cash 60,000 
 M.&S. 30,000 
 
 255,000 
 
 (stores and 
 
 cash) 
 
 ; 15 
 
 23 5 
 
 17!) 
 12.5 
 
 } 12.6 
 1 7.95 
 } 8.5 
 
 40 
 
 5.8 
 
 Elec. Co. 
 
 St. Louis Com.: 
 Union E. L. J G 
 
 16,976,025 
 
 26,417,414 
 1,130,470 
 
 2,477,579 
 
 1,082,813 
 993,867 
 
 1,130,000 
 
 7,378,020 
 
 3,194,159 
 2,768,785 
 2,614,363 
 
 4,700,000 
 
 
 & Pr. Co. 1 E 
 Maryland Com. : 
 Consolidated [ 
 
 G. E. L. & ^ ^ 
 
 P. Co. i^ 
 New York: 
 
 Bklyn. Boro. O. 
 
 Co. 
 
 KingsCo. Lt. Co. 
 
 Queensboro f G 
 G. & Elec. ] E 
 
 I 
 
 1 
 
 
 
 5.38 
 6 1 
 
 .1 5 
 
 3.24 
 
 2 77 
 
 J 
 
 224,931 
 
 042,040 
 
 148,365 
 (including 
 
 $26,364 
 amortiza.) 
 
 349,792 
 
 77,170 
 289,645 
 
 
 
 
 4 55 
 
 Co. ^ 
 Bronx Gas & 
 
 
 
 
 
 4 1' 
 
 Electric Co. 
 Rochester Corn- 
 
 
 
 
 1 36 
 
 ing Elmira Tr. 
 
 Co. 
 Buffalo Gen. 
 
 Elec. Co. 
 Cataract Pr. & 
 
 Conduit Co. 
 Federal Tel. & 
 
 Telg. Co. 
 Washington : 
 Pacific Pr. & Lt. 
 
 Co. 
 
 1,204,006 
 1.516,100 
 1,057,807 
 
 6.53,651 
 
 681,485 
 
 1,1.53,000 
 
 545,419 
 
 286,718 
 
 522.. 521 
 
 512,388 
 366,932 
 
 4.75 
 4.35 
 3.45 
 
 5 44 
 
 
 CODRT DeCISI 
 
 oNs, Working Ca 
 
 PITAL AlLO 
 
 WANCl 
 
 :s 
 
 Consolidated 
 Gas Co. 
 
 $ 
 13,552,482 
 
 $ 
 9,936,910 
 
 3,015,572 
 
 $ 
 
 55,612,435 
 
 4,750,000 1 
 12,179,217 
 
 « 1 
 1,616,000 
 
 (610,000 
 
 suppl.) 
 
 250,000 
 
 (cash and 
 
 suppl.) 
 
 662,118 
 
 (cash 400.2851 
 
 suppl. 261,833, 
 
 119 
 
 1 
 
 ]20.9 
 
 2.9 
 5.7 
 
 Third Ave. Rail- 
 road 
 
 3,164,582 
 
 1,704,477 
 
 1,460,105 
 
 5.44
 
 172 VALUE FOR RATE-MAKING 
 
 required to meet normal average conditions must be allowed to 
 provide for the contingent, unexpected and abnormal condition 
 caused by strikes, financial stringencies, fire, accident or other 
 unusual events, which prevent the normal receipt of revenue or 
 call for more than normal expenditures. 
 
 A third basis of ascertaining normal working capital to be 
 allowed any particular corporation is by fixing a ratio of that 
 capital to the appraised value of the property. A consideration 
 of the decisions of public service commissions and courts indicates 
 that the sum of working capital allowed to cover stores and 
 supplies and cash, together with quick assets, varies from 3 to 6 
 or 7 per cent, of the appraised value of the property; the stores 
 and supplies frequently being about twice the amount of cash 
 or cash assets. As explained above, the amount will, of course, 
 vary with the character of the utility being considered and the 
 practice that exists as to the frequency of rendering bills for 
 service rendered and the promptness of payment of the users. 
 From an examination of the decisions of commissions and courts, 
 the foregoing table, showing typical allowances made for working 
 capital, has been prepared: 
 
 Bond Discount. — There are conflicting opinions and rulings 
 as to whether or not the amount of discount, that is, the differ- 
 ence between the selling price and the par value of bonds, should 
 be included as a part of the property upon which rates are fixed. 
 
 It is generally conceded that the bonds issued by most public 
 utilities must be sold for something less than par. The amount 
 of discount necessary to effect the sale of any particular bonds, 
 will depend primarily upon: 
 
 (a) The rate of interest. 
 
 {b) The ratio of the total bond issue to the total value of the property. 
 
 (c) The class of property given as security for the bonds. 
 
 (d) The ratio of interest charges to total net revenue. 
 
 Under varying conditions of the money market and changes 
 in public opinion, whether warranted by existing circumstances 
 or the result merely of misinformation or prejudice, the amount of 
 discount at which bonds must be sold varies, regardless of the 
 four primary conditions above mentioned. 
 
 Despite mathematical calculations and the contention of 
 certain theorists with regard to the matter, bonds cannot be 
 sold upon a uniform basis of return regardless of the rate of 
 interest, that is, a 5 per cent, bond will bring a better price
 
 FRANCHISES, WORKING CAPITAL, DISCOCXTS \7A 
 
 relatively than a 6 per cent, bond issued by the same utility, 
 on the same property, under the same conditions. For example, 
 a 5 per cent., 20-year bond might sell at 83>^ netting the investor 
 6 per cent, upon his money. If the same issue of bonds were 
 made to bear 6 per cent, rate of interest, all other conditions 
 remaining the same, they probably could not be sold at par in 
 the market. Despite the seeming inconsistency, such con- 
 ditions exist by reason of opinions or prejudices of investors, 
 which must be recognized, admitted and consented to in dealing 
 with bond discounts. 
 
 Whether or not bond discount is to be allowed as a part of 
 the value of property, will depend upon the method followed 
 in determining the value of such property. If, in addition to 
 the value of the physical property, with its intangible elements, 
 there has been included an amount to properly cover the cost 
 of financing and other expenses incidental to raising capital, 
 then there is no reason for including in the total value of the 
 property any amount to cover bond discount. On the other 
 hand, if bond discount is considered a part of the cost of financing, 
 which necessary and essential element of value has not l)ccii 
 taken into account and allowed for in the total value of the 
 property, then the amount of bond discount should be included 
 with the other costs of the property. This latter view is that 
 uniformly taken by the Railroad Commission of Wisconsin, 
 which, both in condemnation and rate cases, seems to look 
 upon bond discount as the cost of financing. 
 
 "It is difficult to say on what grounds such discounts (on bonds) 
 should not be included in the cost of the plant. To so include it, lias 
 been and is the almost universal practice."^ 
 
 Other commissions and courts have recognized the justice 
 and fairness of such allowance as has been shown at some length 
 elsewhere.^ 
 
 In many cases bond discount does not wholly represent the 
 cost of financing; for example, the bonds may sell at 20 points 
 below their par value, whereas the actual cost of financing may i)e 
 only 5 points, leaving 15 points as profit to the purchaser of the 
 bonds (assuming that he eventually realizes par) which profit 
 is a part of the reward for consenting to accept the low rate ot 
 
 1 Hill vs. Antigo Water Company, 2. W. R. C. R. 627. 
 
 2 "Valuation of Public Utility Properties," Henry Floy, page 118.
 
 174 VALUE FOR RATE-MAKING 
 
 interest borne by the bonds. Such profits of the bond buyer 
 must be eventually paid out of the fair return allowed on the 
 property: it should not be charged to the public as an additional 
 expense of rendering service, provided — and only in such case — 
 said expense has already been made to include a fair return on the 
 fair value of the property which value, as determined, covers 
 all costs of financing. 
 
 Bond discount, in reality, is only a method of financing, in 
 which the public may not be directly interested. If the pro- 
 moters and owners of a utility enterprise are allowed such fair rate 
 of return as to cover all reward due them for making an invest- 
 ment under the risks of such business, then that total return to 
 them should provide all interest and profits, regardless of the 
 principle or method of financing that may be followed. To illus- 
 trate: if a utility enterprise requires $100,000 investment includ- 
 ing all property costs, covering in addition to the outlay for phys- 
 ical property, the cost of developing the business, reward for 
 promoters' services and expenses, cost of financing, and all like 
 elements, and if 9 per cent, is considered a fair return above all 
 operating expenses upon the investment, then $9,000 per annum 
 should be allowed the owners as their total return. If the 
 owners, instead of providing all of the $100,000 required, prefer 
 to issue $75,000 of 20-year bonds, selling them at 20 per cent. dis- 
 count so as to furnish $60,000 of cash, leaving only $40,000 cash 
 to be provided by them, they, in fairness, should provide out of 
 the 9,000 actually allowed them as the total reward, such amount 
 as is necessary to amortize the discount on the bonds. Other- 
 wise, the public would be twice paying for the same thing. The 
 owners, in issuing $75,000 par value of bonds, would perhaps 
 put them out, bearing 5 per cent, rate of interest, so that without 
 taking into account the discount of bonds, they would only have 
 to pay $3,750 annual interest, whereas they would be allowed earn- 
 ings of $5,400 per annum on the $60,000 invested. Now if the 
 owners were not compelled to amortize the discount on the bonds, 
 they would thereby make an annual profit of $1,650 in addition 
 to $3,600, the 9 per cent, which we have assumed is the fair rate 
 of return upon the money they actually invested, namely, $40,000. 
 Upon a 4 per cent, sinking fund basis covering a 20-year period, 
 the assumed life of the bonds, there would be required $504 per 
 annum to take care of the bond discount. This added to the 
 assumed interest on the bonds, $3,750, makes a total of $4,254, out
 
 FRANCHISES, WORKING CAPITA!., DfSCOl^XTS I?:, 
 
 of the $5,400 per annum allowed Iheni, which it would properly 
 cost the owners for the $00,000 raised through the sale of bonds. 
 The difference, $1,146, equitably belongs to the owners for the 
 additional risk they assume in practically guaranteeing a bond 
 issue equal to 75 per cent, of the value of the property, and taking 
 the additional risk of having their investment, amounting to 40 
 per cent, of the total, merely a second lien upon the property. 
 In the same way, other illustrations could be given, which, l)y 
 reducing the amount of the bond issue, would increase the amount 
 of money to be provided by the owners, and at the same time 
 very properly reduce their rate of return above the 9 per cent, 
 allowed, as their risk is less, by reason of the fact that they now 
 represent a larger proportion of the total investment in the 
 property. 
 
 In the above discussion it is to be held clearly in mind that bond 
 discount, where not taken into consideration in fixing the value 
 of the property, must be offset and compensated for by including 
 all financial costs fairly to be included as one of the elements of 
 property valuation, such as commissions to a bond and brokerage 
 house on the sale of securities, cost of advertising, printing, legal 
 and trust company charges, and other necessary expenses of 
 similar character. Moreover, when bond discount is excluded 
 from property value, all of those proper expenses, such as bonuses, 
 stock given away or sold at a discount or other concessions, fairly 
 evaluated, that may have to be granted in connection with th(; 
 raising of money for a utility enterprise, must be included as u 
 part of the property value. 
 
 As intimated elsewhere, public authorities too frequently con- 
 sider bond interest practically equivalent to fair return, and in 
 such cases of erroneous procedure, bond discount may properly 
 be included in property value as part of the "initial cost" of 
 borrowed money, that is, the cost for its use over and above the 
 actual cost represented by the nominal or coupon rate of interest. 
 The rate of interest and the discount of the bonds are closely 
 related, and together form the cost of borrowed money, so that 
 the rate of interest on the bonds, without consideration of the 
 discount, does not fix the cost of money. 
 
 Practically it is not always possible to segregate bond discount 
 into its component parts, namely, the cost of the borrowed money 
 itself if it could be obtained without expense and the brokerage 
 or expense of obtaining the same. Recently there has been a
 
 176 VALUE FOR RATE-MAKING 
 
 wider recognition of the various elements going to make up bond 
 discount, and an earnest attempt to support these elements and 
 properly allot them. 
 
 In some instances, bond discount partly represents interest 
 during construction, and in that case is a proper charge against 
 the property account. In the present-day desire to have the 
 value of the property correspond with the value of the physical 
 property, current practice tends to prescribe that bond discount 
 be amortized from income, in order to extinguish such discount 
 as a capital asset.
 
 CHAPTER VITI 
 GOING VALUE 
 
 Going Value must be Allowed. — The term, goinp; value, may 
 properly be taken to mean a value attaching to a pubUc utiUty 
 property as the result of its having an established revenue-pro- 
 ducing business. The total fair value of any utility property 
 aside from franchise value, may be said, broadly, to consist of the 
 sum of at least two quite distinct values, one, represented by the 
 physical property including all of those preliminary and overhead 
 costs necessary to prepare the plant to render service, the other 
 the non-physical but equally important costs to be met in creating 
 the business and revenue. 
 
 Going value may be determined from a consideration of the 
 amounts of money actually expended in the cost of producing the 
 business, the same as the value of physical property may be 
 arrived at from a consideration of the original cost thereof. 
 On the other hand, going value may be determined from con- 
 sideration of the present cost of reproducing the present revenue, 
 just as the value of the physical property is determined from the 
 cost of reproducing that property at present-day prices. In 
 view of the fact that the cost of reproduction is coming to be 
 accepted as the more generally applicable and accurately de- 
 termined basis of value in existing properties, to be consistent, 
 going value, determined upon the basis of reproduction rath(T 
 than upon original cost, should logically become the most 
 generally used basis for determining this element. 
 
 Going value is not in any sense "good will," which latter courts 
 and commissions now unanimously agree has no place m the 
 valuation of a utility property that is a monopoly. Neither does 
 going value include franchise value, which, under the court and 
 commission decisions thus far rendered, is frequently hold to be 
 no more valuable than the actual legitimate expenditure made m 
 securing the franchise, in the way of costs of perfecting title or 
 payments to public authorities. 
 12 177
 
 178 VALUE FOR RATE-MAKING 
 
 Until comparatively recently, it has been strongly argued that 
 the fair value of public utility property should not include any- 
 thing for going value. But the overwhelming weight of recent 
 court decisions holds clearly that going value is properly a part 
 of property value and must be recognized and allowed. 
 
 The recent decision of the Supreme Court of New Jersey upheld 
 the very large allowance made by the Public Utility Com- 
 missioners of New Jersey in ascertaining the value of the property 
 of the Gas Company upon which gas rates were fixed in the so- 
 called Passaic case. The Commission had allowed $1,025,000, 
 namely, 30 per cent, of the value of the structural property, for 
 going value; the cities affected claimed that no allowance should 
 be made for this item, but the Court said: 
 
 "It is necessary, therefore, to determine first whether any allowance 
 at all for going value is proper. We think both on weight of authority 
 and on reason there should be such an allowance. 
 
 "The legal question is whether these items constitute a going value 
 upon which the company is entitled to a return if the individual rate is 
 to be just and reasonable. To this we answer, yes. The argument 
 addressed to us on the other side is that all the so-called going value 
 appears in the valuation of the physical plant at the cost of reproduction; 
 the suggestion is that unless there was going value the physical plant 
 would be a mere junk, and that the difference between the valuation as 
 junk is the true going value. The argument seems to us specious 
 rather than sound. We think that if by value we mean what 
 the economists call exchange value, then a buyer would undoubt- 
 edly give more for a plant already doing a profitable business than for a 
 plant of equal cost, capacity, and future possibilities, but without the 
 established business. To a purchaser the assurance of an immediate 
 return is worth paying for, and we see no reason to doubt the correctness 
 of the ruling of the United States Supreme Court in Omaha vs. Omaha 
 Water Co., 218 U. S. 180. * * * It is true that that was a condemna- 
 tion case and not a rate case, and involved, therefore, a question of 
 exchange value, and not the question of a fair and reasonable valuation 
 as between a public service company and the pubhc. The two l)ases of 
 valuation may properly be different, since upon a sale or condemnation 
 the probability of an assured income and a continuance of the existing 
 rates enters into and affects the exchange value; while in the case of a 
 valuation for the purpose of fixing a rate, the question is what value and 
 rate will tempt the investment of capital, and to what extent existing 
 rates may with justice be lowered. In this view the fallacy of the argu- 
 ment on behalf of the cities is that it requires the investor to suffer all
 
 GOING VALUE 179 
 
 the loss if the enterprise fails, cand deprives him of the chance of addi- 
 tional gain if the enterprise succeeds; and it fails to allow any recompense 
 for the skill shown in developing and conducting the business or even 
 for the value of experience, which is proverbially expensive."' 
 
 Among other explicit court opinions, as to the reasonableness of 
 and necessity for recognition of going value, the following may tic 
 quoted : 
 
 "The receiver of a water company furnishing water to a city for fire 
 purposes without contract as to price is entitled to recover, as a fair 
 CMnpensation for the service, a just proportion of the operating expenses, 
 taxes, and cost of administration paid by the company, and of a just 
 and reasonable return on the cost of reproducing its plant and its going 
 value."'* 
 
 "In consideration of the fact that the system is a going concern, the 
 appraisers should consider, among other things, the present efficiency of 
 the system, the length of time necessary to construct the same de novo, 
 the time and cost needed after construction to develop such new system 
 to the level of the present one in respect to business and income, and 
 the added net income and profits, if any, which by its acquirement as 
 such going concern, would accrue to a purchaser during the time re- 
 quired for such new construction, and for such development of business 
 and income."^ 
 
 "In ascertaining the present value of said plant, for the purpose of 
 fixing rates that shall be charged for services thereon, the Corporation 
 Commission should not confine its consideration to their valuation of 
 the bare physical plant, where such exchange has a large patronage 
 sufficient to pay operating expenses, fixed charges, and some profits, 
 when such patronage has been built up by expenditures of laljor and 
 money for a period of time during which the plant was operated at a 
 loss; but these facts should be considered, and a reasonable amount 
 allowed for its earning capacity as a going concern."' 
 
 "Thus the first question certified required us to decide whether 
 'going value' is to be appraised as a distinct item, or whether it is suffi- 
 cient to regard it as something vague and indefinable to be given some 
 consideration but not enough to be estimated. The valuation of the 
 
 1 Public Service Gas Company vs. Board of Public Utility Commissioners. S7 .\tlanfir 
 657. 
 
 ^ Venner vs. Urbana Water Co., 174 Fed. 348, the 2nd. 
 
 ^ Kennebec Water EHstrict vs. Watersville, 97 Me. 185. ^ 
 
 « Pioneer Telephone & Telegraph vs. Westenhaver, 29 Okla. 429, 34 L. R. A. N. t- IJm.
 
 180 VALUE FOR RATE-MAKING 
 
 physical property was determined by ascertaining the cost of reproduc- 
 tion less accrued depreciation. Preliminary and development expense 
 prior to operation were included, but no allowance was made for the 
 cost of developing the business. By that method, the plant was valued 
 in a sense as a 'going concern/ in other words, 'scrap' values were not 
 taken; but to say that that sufficiently allows for 'going value' is the 
 same as to say that 'going value ' is not to be taken into account. * * * 
 It (the company) would have been entitled to a return on the valuation 
 adopted by the Commission, if it had no customers, but was just ready 
 to begin business, whereas it had a plant in operation with an established 
 business, which everyone knows takes time, labor and money to build 
 
 "It may be conceded that going value has no existence apart from 
 tangible property and that commercially there is but one value, that 
 of the property as a whole, but as the rate cannot be made to depend up- 
 on the exchange values, which would in turn depend upon the rate, it 
 would seem to be necessary to appraise the physical property and the 
 going value separately, and of course that is the case if the cost of repro- 
 duction rule be adopted."' 
 
 " The decision of the Supreme Court in the Cedar Rapids Gas 
 Light Company case is so frequently and vehemently used to 
 prove that this Court does not recognize or allow going value, it 
 seems worth while to go into the details of this case and show 
 therefrom that the Supreme Court actually does recognize going 
 value as an element of value instead of excluding it. 
 
 " The opinion in the Cedar Rapids case decides: 
 
 1. That because constitutional questions not frivolous appear 
 upon the record the motion to dismiss the appeal should be over- 
 ruled. 
 
 2. That there was no contract on the part of the city that the 
 price should be kept high enough to allow a discount for prompt 
 payment. 
 
 3. That the facts were not open to reexamination except as 
 such reexamination might be incidental to the questions raised 
 by the assignments of error. 
 
 4. That it was not such a clear case as to warrant the reversal 
 of a decree which, though final in form, merely postponed a deci- 
 sion upon the merits. 
 
 ' The People ex rel. Kings County Lighting Co. vs. Wilcox et al. Composing Public 
 Service Commission, First District, State of New York, Court of Appeals; decision rendered 
 Apr. 24, 1914, 210 N. Y. 479.
 
 GOING VALUE 181 
 
 " As supporting the conclusion that the case did not require its 
 interference, the Court said : 
 
 'To refer in the first instance to the point just mentioned, wo cannot 
 say as matter of law that at 90 cts. a thousand cubic feet that ccjinpany 
 will be unable to collect payment without losses that will amount to a 
 taking of its property. Then, again, although it is argued that the 
 Court excluded going value; the Court expressly took into account the 
 fact that the plant was in successful operation. What it excluded was 
 the good will or advantage incidental to the possession of a monopoly, 
 so far as that might be supposed to give the plaintitT the power to 
 charge more than a reasonable price. '^ 
 
 " If we construe this correctly, it means that this case is not so 
 clear as to justify interference because in the first place the Court 
 could not say as a matter of law that 90 cts. was confiscatory; in 
 the second place, while it is claimed that the Court excluded 
 going value, the Court in fact took into account this factor; what 
 it excluded was good will which was properly excluded upon the 
 authority of the Consolidated case. 
 
 "To clearly apprehend what the Supreme Court decided, it is 
 necessary to go to the opinion of the Supreme Court of Iowa. 
 That Court said (144 Iowa 434) with reference to going value: 
 
 'Also the sum of $100,000 was included by these witnesses as enhance- 
 ment of value by reason of being a 'going concern.' As previously 
 intimated, the value of the plant is to be estimated in its entirety, rather 
 than by the addition of estimates on its component parts, though the 
 latter course will materially aid in determining the value. Advantages 
 have accrued through the sagacity of its management as contended 
 by appellant. So, too, there are the inevitable mistakes which would 
 not be likely in the construction of a new plant; but to put a new plant 
 in profitable operation, time would be required, and, aside from the 
 intangible element of good will, the fact that the plant is in successful 
 operation constitutes an element of value. 
 
 'As said, the value of the system as completed, earning a present 
 income, is the criterion. Insofar as influenced by income, however, the 
 computation necessarily must be made on the basis of reasonable 
 charges, for whatever is exacted for a pubhc service in excess of this is 
 to be regarded as unlawful. 
 
 'Save as above indicated, the element of value designated a 'going 
 concern' is but another name for 'good will/ which is not to be taken 
 
 1 Cedar Rapids Gas Light Co. vs. Cedar Rapids, 223 U. S. 669.
 
 182 VALUE FOR RATE-MAKING 
 
 into account in a case like this, where the company is granted a mo- 
 nopoly. Cedar Rapids Water Co. vs. City of Cedar Rapids, 118 Iowa 
 234; Wilcox vs. Consolidated Gas Co., 29 Sup. Ct. 192. The witnesses 
 for plaintiff took into account ' good will ' in giving their opinion of the 
 enhancement in value because of being a going concern, and we have 
 no means of separating these so as to ascertain their estimate of the 
 separate advantage of completion so as to earn a present income.' 
 
 " If this means anything, it means that the Supreme Court of 
 Iowa recognized the propriety of considering going value as an 
 element of value. It says distinctly and affirmatively: 'The 
 fact that the plant is in successful operation constitutes an ele- 
 ment of value.' It says further: 'As said, the value of the 
 system as completed, earning a present income, is the criterion.' 
 It calls going value 'an element of value' in distinguishing it 
 from good will, which is excluded. 
 
 " That the Iowa Court might properly have excluded this 
 evidence is obvious. It held that the testimony failed to dis- 
 criminate between good will, which could not be considered, and 
 going value, which must be considered; and the fact that the 
 Court had ' no means of separating these so as to ascertain their 
 estimate of the separate advantage of completion so as to earn a 
 present income' would justify excluding the evidence. Ob- 
 viously, if the Court had intended to hold evidence as to going 
 value as well as good will incompetent, there would have been no 
 occasion for its distinguishing one from the other. 
 
 "It is upon this record that the United States Supreme Court 
 uses the language which has been quoted above, saying not 
 that the Supreme Court of Iowa excluded going value, but that 
 'although it is argued that the Court excluded it, the Court 
 expressly took into account the fact that the plant was in 
 successful operation.' 
 
 "If the Court excluded this evidence, the complainant could 
 have assigned error; and upon this assignment it could have 
 presented to the Supreme Court the question whether or not the 
 ruling was correct. This is the only question that could have 
 been made upon this record. The opinion of the- United States 
 Supreme Court does not show whether this was done, except 
 inferentially in the statement that it is argued that the court 
 excluded going value. The Supreme Court of the United States 
 said :
 
 GOING VALUE 183 
 
 'We perhaps should have adopted a rule as to depreciation somowhat 
 more favorable to the plaintiff, or, it may be, might have allowed this 
 or that item that the state Court struck out, but there is nothing of 
 which we can take notice in the case that could warrant us in changing 
 the result or in saying that the plaintiff did not get as mueii as it couhl 
 expect when leave was reserved for it to try again.' 
 
 "The case was affirmed. Technically and exactly this ufhrin- 
 ance is a decision that the ruling of the court below up(ni this 
 question of testimony was correct, assuming that that (luestioii 
 was properly made and argued, and assuming further that it is 
 not one of the matters to which the court referred in the last 
 extract which has been made from the opinion where it says that 
 in various respects it might not have done what the State Court, 
 did. If this case indicates anything upon the question of going 
 value, the sentence, "then again, although it is argued that the 
 Court excluded going value, the Court expressly took into account 
 the fact that the plant was in successful operation," taken in 
 connection with its opinion in which the Supreme Court of Iowa 
 says: "Aside from the intangible element of good will, the fact 
 that the plant is in successful operation constitutes an element of 
 value," and says further, "as said, the value of the system, as 
 completed, earning a present income is the criterion," it is a recog- 
 nition of the fact that going value cannot be eliminated. 
 
 " Any doubt as to the proper construction of the Cedar Ilapiils 
 case is settled by an analysis of the figures. If we take the 
 valuation of the physical properties which the State Court took 
 in the discussion of the question and make the deductions which 
 it clearly makes, the conclusion that the court included an allow- 
 ance for going value and an allowance for paving over mains is 
 inevitable. The following computation, with references to the 
 pages of the opinion, is^reported in 144 Iowa, where the various 
 items may be found :
 
 184 VALUE FOR RATE-MAKING 
 
 ' Plaintiff's chief expert estimated the phys- 
 ical properties to be worth' (page 438, 
 last line) $365,564 . 41 
 
 'This included $43,580 'increase of value of 
 pipes and mains because of being under- 
 neath the pavement' (line 25, page 437). 
 
 ' Deduct tlie following items included in the 
 foregoing total of $365,564.41 and definitely 
 disallowed by the State Court: 
 
 (1) Working capital included at $25,000 
 and allowed at $2,500 (page 433, line 
 
 23) $22,500.00 
 
 (2) The so-called annex, real estate in- 
 tended for future use, unnecessary for 
 
 present use (page 435, line 22) 16,500.00 
 
 (3) Deductions made by the Court from 
 the valuation placed by the complain- 
 ant upon its real estate $15,000 to 
 
 $20,000 (page 436, line 20) say 17,500.00 
 
 (4) Purifiers (page 436, line 27) 1,600.00 
 
 (5) Deductions on account of excessive 
 price of cast-iron mains (page 436, last 
 paragraph) say 5,000 . 00 
 
 (6) Marion high pressure line ^^ of $5,483 
 
 (page 437, line 23) 4,112.00 
 
 (7) Promotion and organization (page 
 
 438, lines 21 and 31-2) 14,943.69 82,155.69 
 
 $283,408.72 
 
 " This amount, $283,408.72, is the maximum valuation of the 
 physical property because only those deductions have been made 
 that are specifically warranted by the opinion. 
 
 " In the foregoing no deductions are made for either of the 
 following items included in the S365,564.41 although the refer- 
 ences to these items in the opinion unmistakably indicate that 
 they were not allowed to their full amount. 
 
 ' Brought forward $283,408 . 72 
 
 (8) Interest during construction (page 
 
 438, lines 20 and 24) $22,415 . 00 
 
 (9) Engineering (page 438, lines 21 and 
 
 28) 18,679.61 
 
 (10) Increased value of mains because of 
 being underneath paving (page 437, 
 line25) 43,580.00 84,674.61 
 
 $198,734.11
 
 GOING VALUE 185 
 
 "The Court found (page 439, line 33), 'that a fair vahiation of 
 the entire plant is somewhere between S300,U(J0 and S3.')(),()(M).' 
 A deduction from this value of some amount between S2S3, 108.72 
 and $198,734.11 above, will leave what the Court allowed for 
 going value. The following conclusions are inevitable: 
 
 "If interest during construction, engineering and increased 
 value of mains because underneath paving were allowed in full, 
 then the value of the physical property, aside from going value, 
 is $283,408.72, and there is allowed as going value some amount 
 between $16,591.28 and $66,591.28. 
 
 "To contend that the entire item of paving over mains was 
 disallowed in this case, involves increasing the allowance for 
 going value by the amount of this item, $43,580, which would 
 make it somewhere between $60,171.28 and $110,171.28, an 
 amount relatively so large as to render this hypothesis extremely 
 improbable. 
 
 " If the items, interest during construction, engineering and 
 increased value of mains because underneath paving, be sub- 
 stantially reduced, which in view of what is said about them in the 
 opinion is clearly what was done, then the amount of such reduc- 
 tion must be added to what otherwise was allowed for going value. 
 
 "This mathematical demonstration removes all doubt as to the 
 construction of the language in this opinion that has been already 
 referred to. The Court said (page 434) : 
 
 'The fact' that the plant is in successful opcratioir constitutes an 
 elernent of value.' 
 
 "And again, when it stated its conclusion at page 439, the 
 Cqiirtused the sigriifi cant language: . . 
 
 'A careful review of the entire record,' which has been repeated, iias 
 led to the conclusion 'that a fair valuation of the entire plant is some- 
 where between $300,000 and $350,000.' 
 
 "Tlie language of tliese-extraets taken in connection with the 
 items which go to 'make up this valuation makes it impossible 
 that the Court-should have intended to exclude either going value 
 or appreciation iir the value bfthe mains oh account of paving 
 over therti." ^ 
 
 Going Value in Rate Cases.— Going value is now usually 
 recognized as a part of utility property whether the value is being 
 considered in rate cases or for purposes of sale. Practically all of 
 
 1 Brief of E. F. Jones and B. W. Couch,, counsel for The Peoples Gaa Light Co.. 
 Manchester, N. H. Pages 53-58.
 
 186 VALUE FOR RATE-MAKING 
 
 the earlier cases carried to the higher courts for decision were 
 "sale" cases. That is the utilities, mostly water-works compan- 
 ies, were being sold under contracts of purchase or condemnation 
 by cities. Many early decisions by courts in the New England 
 States recognized and allowed going values in the case of purchase 
 of water-works or gas companies. Later the Supreme Court in 
 passing upon the value of the property of the Omaha Water 
 Company, which was being purchased by the City of Omaha, in 
 allowing a very substantial sum, $562,712, for going value said, 
 in referring to the Knoxville Water and Consolidated Gas cases, 
 "Both cases were rate cases and did not concern the ascertain- 
 ment of value under contracts of sale." This has been taken by 
 many authorities to indicate that the Supreme Court would not 
 recognize and allow going value in rate cases as distinct from sale 
 cases. This somewhat gratuitous assumption has never been 
 approved as a principle by any decision of the Supreme Court, 
 although in the Knoxville rate case a definite amount for going 
 value was included without the question being determined 
 whether properly so included. On the other hand, the lower 
 courts and other authorities have repeatedly allowed going value 
 as an element in rate-making and have definitely and expressly 
 stated that it makes no difference whether value is being deter- 
 mined for the purpose of fixing rates or condemnation and sale, 
 going value must be considered and allowed as a part of the fair 
 value of the property. Some instances where the courts have 
 definitely stated that going value is to be allowed in rate cases as 
 well as in sale cases are as follows: 
 
 In the Spring Valley Water-works Company rate case, where an 
 application was made for an injunction to enjoin the enforcement 
 of a rate, the injunction was granted, the opinion stating: 
 
 "It is true this was a condemnation proceeding, and the question was 
 to determine what was just compensation for the appropriation of cor- 
 porate property to a pubUc use, while the case before this Court relates 
 to the fixing of water rates which shall be a just compensation for the 
 appropriation of complainant's property to a public use. It is not per- 
 ceived that there is any difference in the principles applicable to the two 
 cases, and this appears to have been the view of the Supreme Court in 
 San Diego Water Co. vs. San Diego, supra" (118 Gal. 556). 
 
 The complainant in this case contended, as stated by the 
 Court, that it had an established business as a water company
 
 GOING VALUE 187 
 
 and as a going concern, that its plant had a vahic, by rcjison 
 of these advantages, beyond the mere cost of roprofhiction. 
 The Court cites in this connection the leading case of X:ilioiial 
 Water- works Co. vs. Kansas City, 62 Fed. 853, and, after quot- 
 ing from the same, adtls the following: 
 
 "This was also a condemnation proceeding, but, as before stated, the 
 principles of compensation applicable to such a case appear to be 
 applicable to the present case."^ 
 
 In the Des Moines Water Company rate case where the com- 
 pany sought to enjoin the enforcement of an ordinance of the 
 City of Des Moines, fixing rates, on the ground that such rates as 
 fixed were confiscatory, the master in chancery, Mr. G. F. Henry, 
 submitted an unusually carefully prepared report, which contains 
 a most exhaustive review of the cases on going value. The master 
 comments on an earlier decision of the Iowa Court in the Cedar 
 Rapids Water Company case, where the question of whether or 
 not going value should be recognized for rate-making purposes. 
 The master in explanation of an allowance for going value, which 
 "when reduced to dollars and cents is not more than $168,277 and 
 is not less than $167,251," that is practically 10 per cent, of all the 
 other elements of value entering into the property, says: 
 
 "So far as I have been able to learn this expression by the Supreme 
 Court of Iowa of seeming doubt as to the right to include in this "going 
 value' in arriving at the value of a water-works plant in determining a 
 fair rate of profit from the operation of such a plant, is the only expres- 
 sion of this character from any court of last resort. Several of the courts, 
 as will have already been noticed, say that they know of no logical dis- 
 tinction between sale cases and rate cases with respect to the right to 
 include this element of value. I see no logical distinction and am of the 
 opinion, in the light of the foregoing authorities, that it must be 
 included." 
 
 This decision of the master was confirmed in all respects i)y 
 Judge McPherson in September, 1911, with the following state- 
 ment on the question of going value: 
 
 "The master has found and fixed a valuation upon this property, as a 
 going concern, as distinguished from the naked plant. As to this, both 
 reason and authorities sustain him. Everything of a business character 
 is thus valued. * * * A telephone system may have its wires, but 
 before the business can be profitable it must have patrons. It takes 
 
 1 Spring Valley Water-works Company vs. City, etc., of San Francisco, 124 Fed. 594. 865.
 
 188 VALUE FOR RATE-MAKING 
 
 effort and money to get patrons. While obtaining patrons the capital 
 stock is earning but little or nothing. The street car system may have 
 laid its rails and built its power plant, and have bought its cars; but it 
 does not have the value that it afterward will have when its business 
 has been adjusted and the people have adjusted their business and their 
 conveniences to work in harmony with the system thus established. 
 The newspaper plant may have its editors and reporters, and its presses, 
 buildings, and offices. The physical valuation in the one case is just 
 the same as in the other. But two newspapers, possessed of equal 
 physical valuation, are not of the same value, as everybody knows. Two 
 merchants may have the same stock of goods, as to value, and may be 
 equally well located, and may own the same amount of real estate, in 
 value. It is not material whether we call it ' good will ' or the ' value of a 
 going concern,' but there is an intangible value there, and the owner has 
 the right to have it determined on such increased valuation. 
 
 "These rules apply with equal force to a water-works system. It 
 took a long time to build up the system. First, it had to get in touch 
 with the patrons, make contracts, install meters, and establish the busi- 
 ness. During that period the capital stock was not earning what it 
 should have earned. Now that it is a going concern, it is entitled to 
 have these values considered, in arriving at the true valuation of the 
 plant. Such reasoning is indorsed by courts, both national and State 
 Supreme Courts, and such conclusions are the result of sound reasoning. 
 Such are the tests in all other vocations and business enterprises."^ 
 
 The Supreme Court of the State of New York, speaking 
 through Justice Clark, says regarding the improper distinction 
 made by the Public Service Commission of New York, First Dis- 
 trict, in refusing to allow anything for going value in the fair 
 value of the property of the Kings County Lighting Company, a 
 rate case: 
 
 "But 'going value' has been considered and allowed for in the follow- 
 ing rate cases: Missouri, Kansas & Texas R. R. Co. vs. Love (C. C), 
 177 Fed. 493, 496; Shepard vs. Northern Pacific R. R. Co. (C. C), 
 184 Fed. 765, 810; Des Moines Water Co. vs. Des Moines (C. C), 192 
 Fed. 193, 197; Pioneer Tel. & Tel. Co. vs. Westenhaver, 29 Okl. 429, 
 118 Pac. 354, 38 L. R. A. (N. S.) 1209. 
 
 "I am unable to perceive a logical difference between allowing 'going 
 value ' in the valuation of a plant when it is to be taken entirely by the 
 public and allowing the same element when valuing the same plant for 
 rate-making purposes. In each case the thing to be done is the fair 
 appraisement of present value. What difference in principle can there 
 be because in one instance all is taken for the use of the public and in the 
 
 1 192 Fed. 197.
 
 GOING VALUE 189 
 
 other the public limits the earnings? In the case at bar the Commission 
 says it 'disallowed this claim in determining fair value. * * * ]Jut 
 did consider it in fixing the rate of return.' If so, there is no proof of 
 that fact in the record."^ 
 
 The counsel of the New York Commission in arguing on appeal, 
 before the Court of Appeals, in the Kings County Lighting 
 Company case above referred to, criticises the opinion of ti»o 
 Supreme Court of the State, and says: 
 
 "A serious misconception appears in the following ciuotation from 
 the opinion of the Court below (Vol. A, fol. 42) : 
 
 'I am unable to perceive a logical difference between allowing "going 
 value" in the valuation of a plant when it is to be taken entirely by the 
 public and allowing the same element when valuing the same i)lant for 
 rate-making purposes. In each case the thing to be done is the fair 
 appraisement of present value. What difference in principle can there 
 be because in one instance all is taken for the use of the public and in 
 the other the public limits the earnings?' 
 
 "It is fair to say that there has been some confusion in the authorities 
 because a principle which distinguishes purchase cases from rate cases 
 has not always been clearly apprehended.'"^ 
 
 Continuing, the eminent counsel says that this distinction 
 between allowing going value in purchase and rate cases is 
 illustrated and enforced by the decision of the Public Service 
 Commission of New York, Second District, in the Cataract Power 
 & Conduit Company case, which states: 
 
 "I think it must be taken as clear upon principle that there is a funda- 
 mental distinction as to going concern value between rate cases and 
 cases of purchase." 
 
 The Higher Court of Appeals speaking through Judge Miller, 
 quotes the above opinion of Justice Clark, of the Supreme Court, 
 adding: 
 
 "we concur fully in what he has said on the subject and in his 
 conclusion." 
 
 These clear-cut expressions of opinion upon this particular 
 point, have great weight, as, perhaps, never before has it been 
 so definitely and clearly put up to any court to pass upon the 
 question of whether going value should be disallowed in rate cases 
 
 1 People ex rel. Kings County Lighting Co. vs. Wilcox et ah, 141 N. Y. Supp. 677. 
 
 2 Brief of George S. Coleman, Counsel of the Public Service Commission, First DiBtrict. 
 before Court of Appeals, State of New York, page 25.
 
 190 VALUE FOR RATE-MAKING 
 
 in contradistinction to its allowance in sale cases. The subject 
 was presented to the court as one of four questions, certified for 
 review in the following explicit form: 
 
 "Was the relator entitled, upon the facts shown in the record, to 
 have the Commission make an allowance for going value in determining 
 the value of the relator's property used in the public service?" 
 
 The decision of the courts in the matter of allowing going value 
 in both rate and sale cases, would seem to be in line with common 
 sense, as no ordinarily intelligent investor would consent to pay 
 for going value as part of the purchase price of property, and then, 
 precluded by the decision of a Commission in a rate case, be 
 satisfied to go without any return upon that part of his invest- 
 ment in the property which represented going value. 
 
 The Oklahoma Supreme Court in the Pioneer Telephone rate 
 case carefully considered the question whether going value should 
 be allowed in a rate case, and very ably sums up the whole 
 situation in the following extract from that decision : 
 
 "There is no contention that any value on account of unexpired 
 franchise or for good will should be added to the reproductive value, in 
 order to ascertain the present value; but it is contended that, by reason 
 of the fact that appellant's plant has an established system of operation, 
 has at present customers sufficient in number to pay the operating ex- 
 penses and annual depreciation and some profit, it has a value beyond the 
 mere cost of reproducing the plant. This element of value contended 
 for has been generally referred to by the authorities as 'the going-concern 
 value' or 'going value.' No case from the Supreme Court of the United 
 States involving the reasonableness of rates or charges, wherein this 
 question has been considered by that court, has been called to our 
 attention. In Knoxville vs. Knoxville Water Co., supra, the lower court 
 added to the appraisement of the physical properties the sum of $60,000 
 for going concern value. The Supreme Court assumed, without decid- 
 ing, that this item was properly added. There are many cases wherein 
 the fair market value of public service property was involved, under 
 franchises reserving to the municipality the right to purchase the plant 
 at or after a stipulated time for the fair market value thereof. These 
 cases, so far as we have been able to examine them, uniformly hold that, 
 in the absence of a provision in the franchise to the contrary, the going 
 concern element of value must be considered in ascertaining the fair 
 value of the plant. * * * For the purpose of taxation, it is well estab- 
 lished that this element of value must be included in assessing the 
 property. * * * Whether, however, all matters which are considered
 
 GOING VALUE 191 
 
 in the foregoing two classes of cases as part of tlu- going valui", for the 
 purpose involved in those cases, should be considered in doterniiriing llin 
 value as a basis for rate-making is not necessary U) dctcrininc in this 
 case. It is apparent * * * that a complete telephone plant withdut a 
 single subscriber, or with but few subscribers, is less valuable, both to 
 the owner of the plant and to the members of the public it servos, than 
 the same plant with a larger patronage. The more people a sub- 
 scriber can communicate with over the telephone exchange, the more 
 service, as a general rule, is such exchange to him ; and it is only when such 
 exchange has subscribers that the property of the owner invested therein 
 has an earning power. But subscribers arc not obtained wit hout expcrnli- 
 ture of money, labor, and time, during which the capital invested in the 
 plant earns nothing, and often fails to pay operating expenses. The 
 customers must be connected with the system of the plant ; trained em- 
 ployees must be obtained; and a system of operation must be established. 
 Few industries, if any, involving an investment of .S90,000 or more ran 
 be made self-sustaining from the first day of their operation. The 
 uncontradicted evidence in this case discloses that appellant's plant, for 
 the years preceding the first hearing, failed to produce revenue sufficient 
 for operating expenses, current repair, and lay aside an amount for de- 
 preciation. During the time of development, there is a loss of money 
 actually expended and of dividends upon the property invested. How 
 shall this be taken care of? Must it be borne by the owner of the plant 
 or by the initial customers? Or shall it be treated as part of the invest- 
 ment or value of the plant, constituting the basis upon which charges 
 shall be made to all customers who receive the benefits from the increased 
 service-rendering power of the plant by reason of these expenditures? 
 It seems that the last solution is the logical, just, and correct one. 
 If rates were to be charged from the beginning so as to cover these ex- 
 penditures and earn a dividend from the time a plant is first operated, 
 the rate to the first customers would be in many instances, if not in all, so 
 exorbitant as to be prohibitive, and would be so at the time when the 
 plant could be of least service to them. On the other hand, the public 
 cannot expect as a business proposition, or demand as a legal right, that 
 this loss shall be borne by him who furnishes the service, for investors in 
 public service property make such investments for the return they will 
 yield; and if the law required that a portion of the investments shall 
 never yield any return, but shall be a total loss to the investor, capital 
 would unwillingly be placed into such class of investments; but the law, 
 in our opinion, does not so require. Private property can no more be 
 taken in this method for public use without compensation than by any 
 other method. When the use of the property and the expenditures made 
 during the non-expense-paying and non-dividend-paying period of the 
 plant are treated as an element of the value of the property upon which
 
 192 VALUE FOR RATE-MAKING 
 
 fair returns shall be allowed, then the burden is distributed among those 
 who receive the benefits of the expenditures and the use of the property 
 in its enhanced value. * * * AH the evidence of appellant is that the 
 going concern value of the plant in this case is equivalent to 20 per cent, 
 of the reproductive value. This evidence is not contradicted by the 
 state, the position of counsel for the State and of the Commission being 
 that, whatever its amount is, it is not an element of present value forming 
 a basis for the earning of rates. Twenty per cent, of the reproductive 
 value is $18,926.73, which, added to the reproductive value of the phys- 
 ical properties found by the Commission, makes a total present value, 
 on which appellant is entitled to receive a fair return, in the sum of 
 1113,560.42."! 
 
 Without here referring to the many cases of valuation for 
 purposes of sale in which going value has been recognized and 
 allowed as a substantial portion of the total value of the property 
 under consideration, the following decisions by the courts recog- 
 nizing going value in rate cases may pertinently be quoted. 
 
 As early as 1893, Judge Brewer of the Supreme Court rendered 
 a decision which may be said to foreshadow the general rule with 
 regard to going value. The case involved the assessment of a 
 railroad property in Indiana for tax purposes, and antedates the 
 rather famous condemnation case of the National Water-works 
 Company vs. Kansas City by one year. 
 
 "The true value of a line of railroad is something more than an 
 aggregation of the values of separate parts of it, operated separately. It 
 is the aggregate of these values plus that arising from a connected opera- 
 tion of the whole, and each part of the road contributes not merely the 
 value arising from its independent operation, but its mileage proportion 
 of that flowing from a continuous and connected operation of the whole. 
 * * * A notable illustration of this was in the New York Central Rail- 
 road consolidation. * * * Immediately upon the consolidation of 
 these companies, and the operation of the property as a single, connected 
 line of railroad between Albany and Buffalo, the value of the property 
 was recognized in the market as largely in excess of the aggregate of the 
 values of the separate properties. It is unnecessary to enter into an 
 inquiry as to the causes of this. It is enough to notice the fact."^ 
 
 The U. S, Supreme Court in affirming a decision of the Supreme 
 Court in Ohio, in a tax case, held that the organism created by 
 tangible property was a thing of value far in excess of the value 
 of the tangible units. 
 
 ' Pioneer Telephone & Telegraph Company vs. WcBtenhaver, 118 Pac. 359. 
 2 Cleveland C, C. and St. L. R. Co. vs. Backus, 154 U. S. 444.
 
 GOING VALUE 193 
 
 "In the complex civilization of to-day a large portion of tlic wciiltli df a 
 community consists of intangible property" (page 218). 
 
 "Whenever separate articles of tangible property are joined togetlicr, 
 not simply as a unit of ownership, but in a unity of use, tliere is not 
 infrequently developed a property, intangible though it be, which in 
 value exceeds the aggregate of the value of the separate pieces of tangible 
 property" (page 219). 
 
 "In conclusion let us say that this is eminently a ])ractical age; that 
 courts must recognize things as they are and as po.ssessing a value wliich 
 is accorded to them in the markets of the world" (page 225).^ 
 
 In the Knoxville rate case, already referred to, where the master 
 had included $10,000 for " organization, promotion, etc.," and 
 $60,000 for "going concern," the Covirt in reviewing the master's 
 report says, with regard to the allowance for going value: 
 
 " The latter sum we understand to be an expression of the added value 
 of the plant as a whole over the sum of the values of its component parts, 
 which is attached to it because it is in active and successful operation 
 and earning a return. We express no opinion as to the propriety of 
 including these two items in the valuation of the plant, for the purpose 
 for which it is valued in this case, but leave that question to be considered 
 when it necessarily arises. We assume, without deciding, that these 
 items were properly added in this case.""-^ 
 
 While the decision of the Supreme Court, reviewing the decision 
 of the Iowa Court in the Cedar Rapids Gas rate case, is not as 
 explicit as might be desired, the element of going value was held 
 to be properly included as a part of the total value upon which 
 the corporation was entitled to a fair return, as discussed in pre- 
 ceding pages and shown by the extract from the Court'.s decision, 
 as follows: 
 
 "Then again, although it was argued that the Court excluded going 
 value, the Court expressly took into account the fact that the plant was m 
 successful operation. What it excluded was the good will or advantage 
 incident to the possession of a monopoly, so far as we might be supposed 
 to give the plaintiff the power to charge more than a reasonable price. "^ 
 
 The Federal Court in granting an injunction against rates 
 fixed by the Railroad Commission of Texas held that the valua- 
 tion of the railroad property was defective in making no allow- 
 ance for "established business," and adds: 
 
 ' Adams Express Co. vs. Ohio, 166 U. S. 185. 
 2 City of Knoxville vs. Knoxville Water Co., 212 U. S. 9. 
 ' Cedar Rapids Gas Light Co. vs. Cedar Rapids, 223 U. S. 669. 
 13
 
 194 VALUE FOR RATE-MAKING 
 
 "* * * and a system of rates and charges that looks to a valuation 
 fixed on so narrow a basis as that shown to have been adopted by the 
 Commission, and so fixed as to return only a fair profit upon that valua- 
 tion, and which permits no account for betterments made necessary by 
 the growth of trade, seems to me to come clearly within the provision of 
 the fourteenth amendment to the Constitution of the United States, 
 which forbids that a State shall deprive any person of property without 
 due process of law, or deny any person within its jurisdiction the equal 
 protection of the laws. * * * 
 
 "The estimate made on behalf of the railroad in this case of the cost 
 to that company and to its predecessor company of the railroad prop- 
 erty, and the business of that company as it exists to-day, may not be 
 exactly accurate — clearly it is not exactly accurate, but it seems to me 
 that it is not beyond the fair value of the property, as it is shown to 
 have been built up and constituted, and to exist to-day as a going business 
 concern."' 
 
 The Federal Court in a case brought by the receiver of the U. S. 
 Circuit Court for the Southern District of Ohio, to compel the 
 City of Urbana to pay rates sufficiently high to cover a reasonable 
 value of the services rendered in furnishing water, in determining 
 what the property was reasonably worth as a basis upon which to 
 determine rates, said: 
 
 " It is well established that fair compensation for such services includes 
 operating expenses, taxes, cost of administration, and a fair yearly 
 allowance for the maintenance of the plant and such return on the value 
 of the capital and property employed as is just and reasonable. Upon 
 consideration of the testimony of the experts. Hays, Williams, Mead and 
 Hill, I am of the opinion that the fair reproduction value of the property 
 is 1155,000, to which should be added $25,000 as the 'going value' of the 
 property. "2 
 
 In a suit to enjoin the enforcement of the passenger rate of 2 cts. 
 per mile and certain freight rates in the State of Oklahoma, tem- 
 porary injunction was granted, the Circuit Court Judge holding 
 on the subject of going value that: 
 
 "An established railroad system may be worth more than its original 
 cost and more than the mere cost of its physical reproduction. It has 
 passed the initial period of little or no return to its owners which, of 
 greater or less duration, almost always follows construction and is not 
 infrequently marked by default and bankruptcy. The inevitable errors 
 in its building which finite minds and hands cannot avoid have been 
 
 » Metropolitan Trust Co. vs. Houston & T. C. R. Co., 90 Fed. 688. 
 '^C. H, Venner Co. vs. Urbana Water-works, 174 Fed. 352.
 
 GOING VALUE I95 
 
 measurably corrected, time and effort have produced a comnuTcial 
 adjustment between it and the country it was intended to serve, rehitions 
 have been established with patrons, and sources of traffic have Ik-oh 
 opened up and made tributary. In other words, the railroad, unlike 
 one newly constructed, is fully equipped and is doing business as a Koing 
 concern. It has attained a position after many experiences conunori to 
 railroad enterprises which entail loss and cost not paid from current 
 earnings, and which correspondingly make for value."' 
 
 In a case brought by the Water Company to enjoin enforce- 
 ment of an ordinance fixing water rates in the City of Dos Moines, 
 the Court confirming the substantial allowance of the master for 
 going value says: 
 
 "The master has found and fixed a valuation upon this property, as a 
 going concern, as distinguished from the naked plant. As to this, Ijoth 
 reason and authorities sustain him. Everything of a business character 
 is thus valued. * * * A telephone system may have its wires, but 
 before the business can be profitable it must have patrons. "^ 
 
 A fuller quotation of this Court's decision has been given in the 
 preceding pages. The basis for allowing going value as found by 
 the master, and the reasoning of the Court commends itself for its 
 fairness and logic. 
 
 In the gas rate case in the City of Des Moines action was 
 brought to enjoin the enforcement of an ordinance on the ground 
 that the rates as fixed were confiscatory. The master in fixing 
 the value of the plant found a substantial amount for going 
 value, which finding was sustained by the Federal Court, which 
 said: 
 
 "A 'good will ' and a 'going concern' value are often confused and used 
 interchangeably, and I am inclined to believe that in some instances the 
 master's report is subject to this criticism. But whether this is so or not 
 is not of much importance, as it is more of a verbal criticism than a 
 practical one. Under the authorities cited, as well as others easily 
 found from those cited, a 'good will' ^alue, by reason of being a monop- 
 oly such as a gas company has under an ordinance, is not to be reckoned. 
 The item of $300,000 for ' going value ' is quite important in this case. It 
 is contended that if this $300,000 must be added and the consumption of 
 gas remains the same, and the percentage of dividends allowed by the 
 master should stand, there will then be a shortage. The authorities 
 already cited, and which in my opinion are in accord with good sense, 
 
 » Missouri Jf. & T. Ry. Co. vs. Love, 177 Fed. 496. 
 
 * Des Moines Water Co. vs. City of Des Moines, 192 Fed. 197.
 
 196 VALUE FOR RATE-MAKING 
 
 favor the allowance of a ' going value.' Every kind of business, with no 
 exceptions, has a value known as 'going value,' and such 'going value' is 
 in no way connected with the monopoly or 'good will' value. "^ 
 
 Upon granting a preliminary injunction enjoining the Public 
 Service Commission of Arizona from putting into effect rates it 
 had fixed, based upon values it had found for the gas and electric 
 properties of the Phoenix Gas & Electric Light Company 
 excluding any allowance for going value, the Court said : 
 
 "As has been stated, this is the valuation of a going concern as dis- 
 tinguished from the bare bones of the corporation. The courts recog- 
 nize a difference between the value of a plant of this character, without 
 customers or business, and a plant that has been fully established and 
 connected up with a municipal lighting system and with the houses, 
 business places, and factories of regular customers. The present cor- 
 poration was in August of last year a going concern; it was connected 
 up with the municipal lighting system, the houses, business places, fac- 
 tories and other institutions of a prosperous community, and there was 
 nothing more to do except to deliver the service, for which the corpora- 
 tion was fully and efficiently equipped. We think this element of valua- 
 tion should be considered in connection with the other elements of 
 valuation with the view of determining the actual present value of 
 the whole plant. "'- 
 
 The Contra Costa Water-works rate case is sometimes cited 
 as holding against any allowance for going value, whereas an 
 examination of the facts shows that the Court apparently held 
 that the evidence interpreted or viewed by the Court was not 
 sufficient to warrant alloWance for going value, but the Court at 
 the same time stated it did not want to be understood as holding 
 in a water rate case that anything should be allowed for going 
 concern-. A different presentation of the facts and upon the 
 submission of proper evidence the Court will, no doubt, fall in 
 line with practically all courts which have passed on this subject. 
 
 The decision of the Federal Court in the water rate case in San 
 Francisco,^ the decision' of the Supreme Court of Oklahoma in the 
 case of rates of tlie Pioneer Telephone Compahy,"* and the de- 
 cisions of. the Supreme Court and Court of Appeals of New York 
 
 iXJes Moines Gas Co. vs. City of Des Moines, 199 Fed. 204. 
 
 ^ Wm. P. Bonbright et al. vs. W. P. Geary et al., 210 Fed. 44, Corporation Commission 
 of Arizona et al.; Kelly vs. Same. 
 
 ^ Spring Valley Water-works Co. vs. City, etc, of San Francisco, 124- Fed. 574. 
 ^ Pioneer Tel. & Tel. Co. vs. Westenhaver, 118 Pac. 354.
 
 GOING VALUE 197 
 
 State in the gas rate case of the Kings County Company' have 
 been previously referred to and quoted from at length so that 
 they need not here be further cited. 
 
 The recent decision of the United States Supreme Court in 
 case of the Des Moines Gas Company is of particular interest. 
 The conclusions of the master, Judge Sloan, and the confirming 
 decision of the District Court allowing going value in this rate 
 case, have been referred to on the second preceding page. The 
 Supreme Court sustained the lower court and refused to grant 
 an injunction against the rates provided by the city ordinance. 
 Judge Day, who wrote the opinion, after noting that the master 
 had given very thorough consideration of the subject, stated that: 
 
 "Before considering the correctness of the rulings of the master and 
 their confirmation by the district court, it is proper to notice that tliere 
 is considerable difference between counsel as to what the master actu- 
 ally found, as to whether he included the sum of S300,000 which he was 
 disposed to allow for going value in the $2,240,000 valuation found by 
 him, or whether it was added to the estimate of the value of the property 
 already made by him. We think the master intended to value the prop- 
 erty at $2,240,000 exclusive of the 1300,000 which, as we have said, he 
 was at first disposed to allow for going value, and also that he deducted, 
 in reaching the $2,100,000, the $140,000 claimed by the Gas Com- 
 pany as a proper allowance because of the cost of removing and replac- 
 ing pavements, as above stated. We think, too, that it was the master's 
 conclusion that, if the $300,000, which he was at first disposed to allow, 
 as stated, or the $140,000 for paving, were included, the valuation of the 
 plant would be such that a fair return could not be made upon the value 
 of the property, and therefore the company would be entitled to a 
 decree in its favor. It therefore follows that the determination of the 
 correctness of the decree below, confirming the master's report, depends 
 upon and requires a consideration of these two items." 
 
 Then the Court, after stating that the master was at first 
 disposed to allow $300,000 as a separate item to cover going value, 
 quotes his excellent statements on going value as follows: 
 
 "It may be asked upon what basis this amount is determined. The 
 evidence, followed strictly, might require me to make it higher, could 
 my mind rest satisfied that the 'going value' of this concern is worth 
 more, but I cannot feel satisfied that such is the case, and regard S300,000 
 as every dollar it is worth over and above its physical value, and ni my 
 judgment, it is worth that much more than a plant would be that had to 
 
 ' Kings County Lighting Co. vs. Wilcox et al., Public Service Commission, 156 .\pp. Div. 
 603, 210 N. Y. 479.
 
 198 VALUE FOR RATE-MAKING 
 
 develop its business. But that would be much more rapid, in my judg- 
 ment, than is estimated. I think a purchaser would be willing to add 
 this amount for its developed business, and that a seller would not be 
 willing to sell unless he got that much more than its physical value, 
 but I could not give the mental process by which this conclusion is 
 reached any more than a jury could do so, under like circumstances, 
 but it is nevertheless my judgment under all the evidence in the case. 
 
 "The element of 'good will' as applied to the ordinary merchant or 
 manufacturer dealing with the public generally is not considered in 
 estimating the 'going value' of complainant's plant. It cannot be con- 
 sidered in a public utility like the one in question in this case, because 
 the complainant has a monopoly of the business in which it is engaged in 
 the city of Des Moines, and those who desire to use its product must buy 
 of it. They have no choice in the matter. But there is a great differ- 
 ence even in a monopoly which has a business already developed and one 
 that must develop it. The plant of complainant has all its parts work- 
 ing in harmony, performing their several functions in producing and 
 conveying the gas to its customers. These several parts are not only 
 in place, but have been brought to a harmonious operation throughout. 
 Even the employees of the concern are familiar with their duties and 
 experienced in performing them. But without business, no matter how 
 perfect it may be, it would be unprofitable. It is ready, however, for 
 business, and has the business to transact. It was a small concern at 
 the start in 1864, but its books show that it has had a steady growth for 
 many years in the past, and everything indicates that it will continue 
 in the future. There is great difference between such a plant and one 
 whose business must be developed. All a purchaser of such a plant 
 would have to do would be to take charge of the plant, 'touch the 
 button,' and he is making money from the start. There is no element 
 of uncertainty connected with it. 
 
 "He can retain its experienced employees as a rule, should he so 
 desire, at the same wages. There is no question that such a plant has a 
 'going value,' because it is a money maker from the start. 
 
 "The only difficulty is to determine how much its 'going value' is 
 worth. No interest during its construction is allowed, nor anything 
 that is included in the 'overhead charges,' which are part of the physical 
 value. But simply the fact that it has a developed business that will 
 make monej'^ for its owner, with reasonable rates allowed for the prod- 
 uct which it manufactures and sells. 
 
 "That 'good will,' in the sense in which that term is generally used 
 as indicating that element of value which inheres in the fixed and favor- 
 able consideration of customers, arising from an established and well- 
 known and well-conducted business, has no place in the fixing of valua- 
 tion for the purpose of rate-making of public service corporations of this 
 character, was established in Willcox vs. Consolidated Gas Co., 212 U. S.
 
 GOING VALUE 199 
 
 19, 52, 53 L. ed. 382, 399, 48 L.R.A. (N.S.) 1134, 29 Sup. Ct. Rep. 192, 
 ISAnn. Cas. 1034."! 
 
 Judge Day, himself, then discusses "going value," as follows: 
 
 "That there is an element of value in an assembled and established 
 plant, doing business and earning money, over one not thus advanced, is 
 self-evident. This element of value is a property right, and should be 
 considered in determining the value of the property, upon which the 
 owner has a right to make a fair return when the same is privately owned 
 although dedicated to public use." 
 
 Thus far, we can agree with what has been said in regard to 
 going value, but at this point in his opinion, Judge Day soonis to 
 confuse "going value" with "overhead charges," for which latter 
 item 
 
 "the master allowed 15 per cent, upon the base value (exclusive of real 
 estate) or $296,254, in addition to his allowance of $6,923 for organiza- 
 tion expense." 
 
 The master, apparently, had clearly in mind the fact that 
 "going value" was separate and distinct from "overhead 
 charges" or "organization expenses," which he specified covered 
 expenditures for promotion, engineering, superintendence during 
 construction, insurance, contingencies, administration expenses, 
 interest and taxes during construction, definitely adding 
 
 "no overhead charges that do not adhere in and add to the cost thereof, 
 should be allowed as a part of its (the plant's) physical value." 
 
 The Court, apparently overlooking this clear statement of the 
 master, confuses the allowance for these items with " going value," 
 as indicated by the following: 
 
 "In this case, what may be called the inception cost of the enterprise 
 entering into the establishing of a going concern had long since been 
 
 incurred." 
 
 if * * * ** * * 
 
 "These items of expense in development are often called overhead 
 charges, for which, as we have already seen, the master allowed 15 per 
 cent, upon the base value." 
 
 Then Judge Day, states that, in line with the Cedar Rapids 
 case,^ when 
 
 "the value of the property fixed as the master certifies upon the basis 
 of the plant in successful operation and overhead charges have been 
 
 1 Des Moines Gas Co. vs. City of Des Moines et al. 35 Supreme Ct. Rep. 811. 
 * Cedar Rapids Gas Light case vs. Cedar Rapids, 223 U. S. 6oo.
 
 200 VALUE FOR RATE-MAKING 
 
 allowed for the items and in the sums already stated, it cannot be 
 said, in view of the facts in this case, that the element of the going 
 value has not been given the consideration it deserves," 
 
 thereby indicating that, in his opinion, the value of the property 
 as found by the master included going value, the basis of his 
 opinion being the following figures of the master: 
 
 Working capital $ 140,000 
 
 Real estate 150,000 
 
 Reorganization expenses 6,923 
 
 Meters in stock 6,603 
 
 Present value of physical property aside from 
 above items L937,402 
 
 Total physical value $2,240,928 
 
 From the statement of Judge Day, given at the top of page 
 199, he evidently recognizes that going value is an element of 
 value in the property of a public utility, over and above the 
 value of the structural plant, and thought he was allowing such 
 going value when he was allowing "overhead charges" and 
 "organization expenses" which, of course, was not the case as 
 clearly shown by the master. The principal conclusion to be 
 drawn from the Des Moines Gas case therefore is not whether 
 going value was allowed in the figures representing the value of 
 the property accepted by the Supreme Court, but rather, whether 
 the Supreme Court recognized going value as an element of prop- 
 erty value and thought it was allowing such value in sustaining 
 the figures fixed by the master. There can be no question but that 
 Judge Day thought he was basing his opinion and the decision 
 of the Supreme Court upon a value which included going value 
 and, even though he erred in this, the principle that going value 
 will be recognized and allowed by the Supreme Court still stands, 
 unaffected by the Des Moines case. 
 
 Going Value, Four Meanings. — Although going value is used 
 as indicating a value of utility property which exists in addition 
 to that of the mere physical or structural property, the term is 
 employed loosely to indicate quite different intangible elements. 
 The various shades of meaning may be grouped into four general 
 classes. 
 
 First: — Expenses. — A value based on the cost or estimated cost 
 of making a complete physical plant into an income producing 
 property. This idea of going value is based on actual expendi-
 
 GOING VALUE 201 
 
 tures which have been made in attaching the business, securing 
 customers, advertising, free equipment or services furnished 
 consumers, perfecting organization and espirit de corpn among 
 employees, and those other items which necessitate extra expense 
 in originating and creating a Hve property. These expenses are 
 not in reality a part of regular operating expenses but rather 
 they are costs which are incurred but once in the development 
 of any given original business. They are quite distinct from 
 such costs as fuel and labor, which may create a deficiency in 
 operating a property that has small or inadequate returns during 
 the early years but which operating expenses must necessarily be 
 incurred in order to permit the corporation to build up that 
 ultimate business which warrants the existence of the corpora- 
 tion itself. Under present methods of public service regulation 
 accounting, it is possible to ascertain the exact cost of the class 
 of items herein referred to as constituting the elements from 
 which going value is ascertained, but heretofore, with less ex- 
 acting requirements of bookkeeping, the experience of experts 
 and operators of utilities has been taken in fixing this intangible 
 value. Based on experience and a knowledge of the amount of 
 money which corporations are willing to expend in order to ob- 
 tain a given revenue, one-half or even the whole amount of annual 
 gross revenue has been taken as the measure of going value. 
 
 '-In the writer's experience, going concern value has usually been 
 found to be between the net and gross income of the plant for a period 
 of one year (at the date of taking). It may be largely effected, how- 
 ever, by the period required for the development of the business."' 
 
 Based on the cost of soHcitirig, connecting up and getting ready 
 to supply a customer, a certain fixed sum per service, somewhat 
 frequently taken at S30 per meter in gas works, has been given 
 as an arbitrary but fair basis for determination of going value. 
 Still another rule of thumb metht)d is to take a per cent, of the 
 value of the physical plant as representing going value, these 
 percentages vary from about 10 per cent, up to as high as 50 per 
 cent, or even- 75 per cent, and are based on knowledge of the cost 
 of obtaining a revenue for different properties under various 
 conditions of installation and operation. 
 
 An authoritative statement asto the proper method of de- 
 termining going concern value, in a particular case says: 
 
 » Mr. Leonard Metcalf, in the Tramactions of .the Amer. Society of Civil Engineers, 
 paper No. 1105, page 31.
 
 202 VALUE FOR RATE-MAKING 
 
 "This being the cost of developing the business and efficiency of the 
 companj'^ from the beginning of operation up to the present stage. 
 Figures for determining it exactly in this case are difficult to obtain. 
 
 " In some other cases when steam plants constructed under normal 
 conditions were operated and when the development was made without 
 unusual difficulties, it has been found from records and experience that 
 going concern value equals approximately 25 per cent, of plant value. 
 
 " As in such cases the physical plant values are ordinarily aboi^t four 
 times the gross earnings, the amount of the gross earnings then coin- 
 cides approximately with going concern value, and as going concern 
 value will ordinarily be more closely related to gross earnings than to 
 plant values^ the going concern value may be said to be approximately 
 equal to the amount of the annual gross earnings at the time of ap- 
 praisal, provided proper judgment has been exercised in the develop- 
 ment and operation of the property."^ 
 
 These somewhat approximate and somewhat arbitrary methods 
 of fixing going value have been frequently recognized and ac- 
 cepted by courts and commissions. In the Passaic Gas case, the 
 Board of Public Utility Commissioners of New Jersey accepted 
 the testimony of one of the experts and allowed 30 per cent, of 
 the structural value, including therein certain items which are 
 usually not included as a part of the going value. 
 
 "We are impressed with the evident solidity of Mr. Royce's testimony 
 as to the ratio of going value to structural value. In order that there 
 may be no mistake as to what he includes in going value, his own 
 definition, explicitly asked for as a definition, should be recorded as given 
 on page 1425 of the evidence. It includes practically all elements 
 of value which the company may possess outside of its actual structural 
 value and the intangible worth or value of its quick assets. 
 
 "Asked explicitly by Judge Armstrong: 'You include in that what- 
 ever value would attach to the franchise value of (or?) advantage for 
 the value of a going business, a live business, producing a profit; the 
 prospective increase, and the opportunity foT the investment of addi- 
 tional capital in enlargements, and all that would ydn?' Mr. Royce 
 answered, 'Yes, sir, and the value that coqaes, when a plant is prop- 
 erly handled, of getting the apparatus itself into such shape that it may 
 be worked at its point of greatest efficiency. * * *' (Evidence, 
 pages 1425, 1426.) 
 
 "Recalled, Mr. Royce, being asked if his compilation of costs t&kes into 
 account ' the preliminary costs of the party which went to look over the 
 
 1 Testimony of W. H. Blogd, pp. 919, 920, before tte Public Service Cominisai'on of 
 the State of Migsouri, in McGregoT-Noe Hardware Co. vs. Springfield Gas & Elec- 
 tric Co., 1913.
 
 GOING VALUE 203 
 
 field and of organizing the business or of getting their franchises,' lie 
 replies that he is speaking of 'the company ready to do business,' but 
 adds, correcting himself or explaining himself, that it applies 'either 
 before or after' the construction of the plant (Evidence, piigo 17SM). 
 
 "We must bear in mind the definition given by Mr. Royce himself, 
 when asked specifically to define the term 'going value,' as 'prac- 
 tically all the elements of value which the company may possess outside 
 of its actual structural value and the tangible worth or value of its 
 quick assets' (Evidence, page 1425). With this definition of 'going 
 value,' we must compare his matured statement that he would say 
 'without any question that the minimum of the going value of the 
 property would be the sum of those three items, or perhaps 30 per cent, 
 of the structural value of the plant; and roughly speaking and con- 
 sidering that we are to take up a new proposition of tliis kind I tliink 
 we should have to spread that amount in the variation of the going 
 value' (Evidence, page 1787). 
 
 "Structural value, according to Mr. Royce, includes contractor's 
 profit on structures. His estimate of 30 per cent, moreover is a mini- 
 mum (Evidence, page 1787); but 'for purposes of this kind that would 
 be a fair basis' (Evidence, page 1862). He testified out of a wide 
 experience that this is a fairly common or average allowance for going 
 value. He testified that in the case of this particular company: 
 
 *I believe that the actual cost of developing, of getting the new 
 business and of creating efficiency in operation, together with some 
 losses, during the various periods of construction, has been at least 
 30 per cent, of the actual structural cost.' 
 
 "He was unshaken on cross-examination, and made clear that this 
 percentage applied not merely to the structural cost with which a 
 company might start in business, but to the structural cost of ex- 
 tensions as well (Evidence, page 1849). He is also on record that this 
 value of going concern does not suffer depreciation (Evidence, page 
 1865), but is fully as stable as real estate (Evidence, page 1866). In 
 the absence of accounting records going back more than al)Out a dozen 
 years, and in view of the very wide expert experience of untlerlying and 
 supporting Mr. Royce's testimony, we incline to think that 30 per cent, 
 of present structural value, new, may well be taken as a fair presumptive 
 measure of the total going concern value of the company. This 30 
 per cent, is to be taken on the fair structural value, new, of the com- 
 pany's plant and distribution system, working capital being excluded."' 
 
 Similarly the Oklahoma Supreme Court added 20 per cent, to 
 the "reproductive value" of the physical properties as found l)y 
 the Oklahoma Corporation Commission in overruling that Coin- 
 
 > Hearing on Rates of the Public Service Gas Company, before the board of Public 
 Utility Commrs., Dec. 26, 1912, page 42.
 
 204 VALUE FOR RATE-MAKING 
 
 mission and establishing the correct value upon which to fix 
 rates. ^ 
 
 The special master in the Des Moines Water Company case 
 fixed the going concern value at practically 10 per cent, of the 
 physical value of the property,^ and other similar instances might 
 be cited. 
 
 While proper weight must be given to the testimony and ex- 
 perience of men qualified to speak on the subject, this method of 
 determining going value is not always as satisfactory to some 
 minds as certain other methods which can be worked out with 
 greater mathematical exactness. Moreover, it will be recognized 
 that the ratio of going value to the cost of physical property is 
 not constant under varying conditions such as the comparatively 
 high price of labor and materials in one property, as against the 
 low cost of these elements in another property, or the saturation 
 of the territory as against the undeveloped business of a second 
 corporation or the investment required in one class of utility 
 property which may be relatively large per dollar of revenue, as 
 compared with the investment required by another utility of an 
 entirely different type. 
 
 Second: — Deficiency. — Going value has sometimes been defined 
 by the use of the term "development expenses," meaning the de- 
 ficiency in revenue to provide operating expenses and fair return, 
 which deficiency accrues in practically every utility during the first 
 few years of operation, while the business is being attached and 
 the revenue built up to a point that justifies the existence of the 
 utility. Where information is lacking as to the actual deficiency 
 in the amount heretofore earned, as compared with the amount 
 which should be earned in order to make a fair return to the 
 utility on the value of its property, existing going value may be 
 estimated by computing the similar loss that would accrue to a 
 utility assumed to begin construction of its plant at the present 
 time, compared with the actual revenue of the existing plant. 
 The condition is almost inconceivable that any public utility 
 corporation can earn a fair return upon the value of its property 
 from the very first day it is started. Comparatively few cor- 
 porations have been able to earn a gross income even for the first 
 year, in which complete operation begins, that is, sufficient to 
 provide operating expenses, taxes and a fair return upon the in- 
 
 1 Pioneer Telephone & Telegraph Co. vs. Westenhaver, 118 Pac. 354. 
 ^ Des Moines Water Co. vs. City of Des Moines, 192 Fed. 193.
 
 GOING VALUE 205 
 
 vestment. One of the single notorious instances of this class was 
 the subway in New York City, which being financed largely on 
 municipal credit, has relatively low fixed charges. 
 
 The fairness and appropriateness of recognizing, as a part of 
 the cost of a property, the expense of constructing the business 
 apart from and in addition to the physical property is not a new 
 or modern idea. 
 
 At least 70 years ago, in 1845, Asa Whitney made a definite 
 estimate of the probable development cost, or deficit in fair re- 
 turn, of the Northern Pacific Railway.^ 
 
 The Railroad Commission of Wisconsin early recognized the 
 fact that: 
 
 "New plants are seldom paying at the start. Several years arc usu- 
 ally required before they obtain a sufficient amount of business or earn- 
 ings to cover operating expenses, including depreciation and a reason- 
 able rate of interest upon the investment. The amount by which the 
 earnings fail to meet these requirements may thus be regarded as 
 deficits from the operation. These deficits constitute the cost of build- 
 ing up the business of the plant. They are as much a part of the cost 
 of building up the business as loss of interest during the construction 
 of the plant is a part of the cost of its construction. They are taken 
 into account by those who enter upon such undertakings, and if they 
 cannot be recovered in some way, the plant fails by that much to 
 yield reasonable returns upon the amount that has been expended upon 
 it and its business. * * * 
 
 "The cost of developing a business of water-works may be made up 
 of many different kinds of expenditures. It may include the cost of 
 advertising, sohciting, demonstrations showing the advantage of 
 having water under pressure in the houses, of making free connections, 
 of the granting of lower than the regular rates, and of many other 
 outlays of this character in order to secure customers. It may also 
 include losses to the investors because of the fact that the plant in their 
 earlier years failed to earn enough to meet all the requirements for 
 operating expenses, including depreciation and a reasonable return 
 upon the investment. If the direct outlays for securing business are 
 charged to operating expenses, as they should be, instead of to the capital 
 account, then the cost of acquiring a paying business would be repre- 
 sented by the deficits, or by the amounts by which the gross earnings 
 fall short of covering the cost of operation, as stated, including fair re- 
 turns to the investors. * * * 
 
 "It thus appears that the cost of building up the business of a plant 
 is in most cases as unavoidable as the cost of the construction of the 
 
 ' "Engineering and Contracting," Aug. 19, 1914, page 1G9.
 
 206 VALUE FOR RATE-MAKING 
 
 plant itself; that when such costs are incurred, they must be reim- 
 bursed in some form bj^ the consumers in order that capital may be 
 secured; that such reimbursement is equitable as between investors 
 and consumers; and that this is a just method of dealing with such costs 
 for other reasons. If this is sound, it also follows that the cost of the 
 business must also be taken into consideration in determining the value 
 of the plants for rate-fixing purposes. "^ 
 
 The principles enumerated above have been adhered to con- 
 sistently by the Wisconsin Commission in a large number of 
 other decisions so that this method of measuring going value by 
 past deficits has very generally become to be known as the "Wis- 
 consin Method." More recently, this same Commission has 
 given consideration and apparently based allowance for going 
 value upon other lines of proof than the deficit method, namely, 
 upon the comparative plant basis which is discussed hereafter. 
 The Wisconsin or "deficit method" of estimating going value 
 has been quite widely recognized and followed by other public 
 authorities and courts. The Supreme Court of Wisconsin in a 
 recent decision upheld the Wisconsin Commission in its allow- 
 ance of going value to the Appleton Water-works Company 
 based on the deficit method, although the physical property 
 was not in the best of condition and the revenue was not suffi- 
 cient to pay all operating expenses, an allowance for depreciation 
 and a fair return on the value of the property. 
 
 Because of the fact that deficits always accrue at the start, 
 the Oklahoma Court has definitely recognized that fact and 
 stated such losses should be capitalized. 
 
 "Few industries, if any, involving an investment of $90,000 or more, 
 can be made self-sustaining from the first day of their operation. * * * 
 During the time of development there is a loss of money actually ex- 
 pended and of dividends upon the property invested. How shall this 
 be taken care of? * * * or shall it be treated as part of the investment 
 or value of the plant, constituting the basis upon which charges shall 
 be made to all customers who receive the benefits from the increased 
 service-rendering power of the plant by reason of these expenditures? 
 It seems that the last solution is the logical, just, and correct one."^ 
 
 The Public Service Commission of New Hampshire has said: 
 
 "Technically, depreciation should be made good out of earnings. 
 But it is out of the question for this company to make good out of its 
 
 • Hill V8. AntiKO Water Co., 3 W. R. C. R. 623. 
 
 * Pioneer Telephone & Telegraph Co. vs. Westenhaver, 118 Pac. 354.
 
 GOING VAIA-E 207 
 
 earnings a loss of $250,000. We, tlioreforo, find that justice to tl..' 
 company, and the public good alike, reciuire that the delicier»ry i„ (|„. 
 present depreciated value of the company's pn.perty, Iwlow th.; amount 
 actually invested by the stockholders, be regarded as a cost of dovelo|H 
 ing the business and, as such, added to any depreciated value to dot«T- 
 mine the present fair value of the company's i)r()p('rty devoted t(. the 
 public service; and that the company should, hereafter, be allowed to 
 earn annually a fair return upon $1,402,750, the amount of its h<,„.i 
 fide investment. * * * " 
 
 "The present depreciated value of the property, exchidrng .ii)- 
 preciation in land values, is $1,050,000. There has, therefore. l).<en :i 
 total depreciation of $450,000 of which $100,000 has been made good 
 out of earnings, while the balance of $350,000 remains a loss to the stock- 
 holders, unless it is in some way made good to them."' 
 
 The Court of Appeals of New York State has recognized and 
 approved the deficit method for measuring going value. 
 
 "It takes time to put a new enterprise of any magnitude on its feet, 
 after the construction work has been finished. Mistakes of con- 
 struction have to be corrected. Substitutions have to be made. 
 Economies have to be studied. Experiments have to be made, which 
 sometimes turn out to be useless. An organization has to be perfected. 
 Business has to be solicited and advertised for. In the case of a ga.s 
 company, gratuitous work has to be done, such as selling appliances at 
 less than a fair profit and demonstrating new devices to induce con- 
 sumption of gas and to educate the public up to the maximum point of 
 consumption. None of those things is reflected in the value of the 
 physical property, unless, of course, exchange value be taken, which 
 is not admis-sible in a rate case. The company starts out with the 
 "bare bones" of the plant, to borrow Mr. Justice Lurton's phrase in 
 Omaha Water-works Case, supra. By the expenditures of time, labor, 
 and money, it coordinates those bones into an efficient working organ- 
 ism, and acquires a paying business. The proper and reasonable 
 cost of doing that, whether included in operating expenses or not, is a.s 
 much a part of the investment of the company as the cost of the physical 
 property. 
 
 Investors in a new enterprise have to be satisfied as a rule with 
 meager or no returns while the business is being built up. In a busi- 
 ness subject only to the natural laws of trade, they expect to make up 
 for the early lean years by large profits later. In a business, classified 
 among public callings, the rate-making power must allow for the losses 
 
 ' Report of P. S. Commission, State of New Hampshire No. D-159. Vol. II. No. 2. Not. 
 20, 1914, page 90.
 
 208 VALUE FOR RATE-MAKING 
 
 during the lean years, or their rate will be confiscatory, and of course 
 will drive investors from the field. 
 
 To view the matter in another aspect, take the case of a public service 
 corporation with a plant constructed just ready to serve the public. It 
 is going to take time and cost money to develop the highest efficiency of 
 the plant and to establish the business. Three courses seem to be open 
 with respect to rate-making, viz.: (1) To charge rates from the start 
 sufficient to make a fair return to the investor and to pay the develop- 
 ment expenses from earnings, a course likely to result in prohibitive 
 rates, except under rare and favorable circumstances; (2) to treat the 
 development expenses as a loss to be recouped out of earnings, but to be 
 spread over a number of years, in other words, as a debt to be amortized 
 — that involves complications, but would seem to be fairer to the public, 
 and certainly more practical than the first; (3) to treat the development 
 expenses, whether paid from earnings or not, as a part of the capital 
 account for the purpose of fixing the charge to the public. The last 
 course would seem to be fairest to both the public and the company, as 
 well as the most practical."^ 
 
 The New York Court's decision, as to going value, is based 
 on a practical consideration of the way a public utility's revenue 
 is built up, but the following dicta in the same case to the effect 
 that no going value exists in case of a successful corporation, is 
 apparently neither good law nor good logic, as clearly shown by 
 Judge Day of the Supreme Court in the recent decision of Des 
 Moines Gas Company case, where Judge Day quotes and ap- 
 proves the following statement of the master: "There is no 
 question that such a plant has a 'going value,' because it is a 
 money maker from the start. "^ 
 
 " Making proper allowance for the matters just considered and perhaps 
 for others which do not occur to me, I define 'going value' for rate pur- 
 poses as involved in this case to be the amount equal to the deficiency 
 of net earnings below a fair return on the actual investment due solely 
 to the time and expenditures reasonably necessary and proper to the 
 development of the business and property to its present stage, and not 
 comprised in the valuation of the physical property. 
 
 "It may be conceded that going value has no existence apart from 
 tangible property and that commercially there is but one value, that 
 of the property as a whole, but as the rate cannot be made to depend 
 upon the exchange value, which would in turn depend upon the rate, it 
 
 • People ex rel. Kings County Lighting Co. vs. Wilcox, 210 N.Y., 479. 
 
 ^ Des Moines Gas Co. vs. City of Des Moines, et al., 35 Supreme Court Rept. 811.
 
 GOING VALUE 209 
 
 would seem to be necessary to appraise the physical property and the 
 going value separately, and of course that is the case if the cost of 
 reproduction rule be adopted. 
 
 "It remains to consider how 'going value' is to be appraised. 
 
 "Obviously, the most satisfactory method is to show the actual 
 experience of the company, the original investment, its earnings from 
 the start, the time actually required and expenses incurred in Ijuilding 
 up the business, all expenditures not reflected by the present condition 
 of the physical property, the extent of which bad managoinont or othf-r 
 causes prevented or depleted earnings, and any other facts bearing on 
 the question, keeping in mind that the ultimate act to be determined is 
 not the amount of the expenditures, but the deficiency in the fair return 
 to the investors due to the causes under consideration. The business 
 in this case was 20 years old, the books of the old company were not 
 available, and it is of course problematical whether, if produced, they 
 would have shown the necessary facts. The question, therefore, had 
 to be determined, as all questions of fact have to be, by the best evidence 
 available. Here, I may repeat, that mere difficulty in the proof would not 
 justify a confiscatory rate. The value of the physical property was 
 shown by opinion evidence as to the cost of reproduction. The same 
 kind of evidence was given by two witnesses for the relator as to the 
 cost of building up the business to its present state. "^ 
 
 The conclusion stated that going value "equals the deficiency 
 in net earnings" would seem to assume that possibly large, past 
 profits, declared as dividends, do not belong to the stockholders 
 of that period and because such dividends were not put into the 
 property to wipe out that part of the capital investment nece.';- 
 sarily required to build up the business and revenue of the 
 corporation, therefore the existing stockholders may now be 
 penalized by reducing the value of their property to that merely of 
 the structural plant. Or again, if by unusual opportunity, fore- 
 sight and ability, the owners of a property have been able to wipe 
 out the early losses incurred in creating the revenue, then the 
 value of their property is to be that much less than the value of an 
 identical property elsewhere, operating under ordinary condi- 
 tions, with normal ability, the early losses of which have not been 
 recovered. 
 
 If, on the one hand, the deficit theory of measuring going value 
 is to be limited in its application— and very properly so— to the 
 normal period in which the normal property will put itself upon a 
 
 1 People ex rel. Kings County Lighting Co. vs. Wilcox, Court of Appeals, decision ren- 
 dered Apr. 24, 1914. 210 N. Y., 479. 
 14
 
 210 VALUE FOR RATE-MAKING 
 
 paying basis, thereby excluding the property which is unsuccessful 
 or which takes an abnormally long period in which to prove itself 
 a success, then, on the other hand, logically and fairly, the same 
 normal measure of going value must be allowed the exceptionally 
 successful corporation which puts itself on a paying basis in an 
 abnormally short period. The normal cost of developing the 
 business must be allowed as a part of the value of the property 
 of the successful, or abnormally successful corporation just the 
 same as that same normal cost would be allowed the unsuccessful 
 corporation regardless of the fact that the actual cost may have 
 been much larger than what is or what should be recognized as the 
 normal cost of developing the business. 
 
 Criticism of the New York Courts' conclusions in the above 
 quoted excerpt from the Kings County decision has been made by 
 one of the most eminent legal authorities in rate questions, the 
 late Mr. Chas. F. Mathewson, of New York, and is here quoted at 
 length: 
 
 "In one respect I venture to disagree with the expressions of the 
 learned Judge who wrote the opinion in the case last quoted. 
 
 "He defines 'going value' for 'rate purposes' as 'the amount equal to 
 the deficiency of net earnings below a fair return on the actual invest- 
 ment' due to the expenditures reasonably incurred in the development 
 of business and property of the company, in addition to the value of the 
 physical property. I believe it to be the sound doctrine that such 
 expenditure represents the value of the 'going concern' development, 
 whether there is a deficiency in net earnings by reason of such expendi- 
 ture or not. The language of the learned Justice, literally read, would 
 indicate that there could be no 'going concern' value in the case of a 
 corporation which earned a fair return on the investment from the 
 beginning; and while the discussion may be academic because there is 
 rarely found such a corporation, yet his proposition as quoted is 
 believed to be unsound. Thus, a street railway system may be prof- 
 itable and pay adequate dividends from the outset; and yet it takes 
 years, as in the case of the Metropolitan System, and a large expenditure, 
 to acquire the experience and knowledge of conditions and traffic and 
 methods of operation which will produce the best results, which expendi- 
 tures will not have to be repeated, which would not have been necessary 
 had the management been omniscient at the outset, and the result of 
 which is a fund of knowledge and efficiency for which a purchaser would 
 gladly pay as part of the capital value of the enterprise. This knowledge 
 and experience is just as valuable to the owner of the property, and forms 
 just as important a part of the whole investment, whether the moneys
 
 GOING VALUE -JH 
 
 which purchase the experience and produce and devcldp the hu.sinc«s 
 conies from rates paid by consumers or from capital horrowed hy the 
 owner. 
 
 "If the company was permitted in default of regulation by the lenis- 
 lature to charge rates so high that it was able to pay excessive dividends 
 to stockholders, as well as to meet the expenditures of this experimental 
 period which produces the 'going concern value,' that was merely the go(»d 
 fortune of the stockholders. What they earned and paid to themselves 
 in dividends belongs to them and cannot be taken away; and it df)es not 
 in any way conflict with the proposition that the development of their 
 business and the passing through the experimental period of its opera- 
 tion at a large expense, never to be repeated, produce an element of 
 value in the whole business which is not dependent for its existence uiK»n 
 the source from which the moneys came which produced it, or the (\uvs- 
 tion as to whether it resulted in a curtailment of dividends while it wa.s 
 being developed. This we believe to be the view of the weight of 
 authority."^ 
 
 In this connection it should be noted that in the Passaic Cias 
 case, where the Public Utility Commissioners of New Jersey have 
 allowed practically 30 per cent, of the value of the physical prop- 
 erty, including working capital, as an additional amount repre- 
 senting going value, the sum of $4,750,000, being the value 
 of the property upon which rates were fixed, the Supreme 
 Court of New Jersey very properly upheld the conclusion of the 
 Commission, to the effect that even if the costs incurred in devel- 
 oping the business had been paid for out of previous earnings, 
 exacted from the consumers, nevertheless going value should 
 properly be allowed in determining the present fair value of the 
 property, on which rates should be fixed. 
 
 With regard to the use of early deficits as a measurement of 
 present going value, it may justly be argued that, it is not logical 
 to use historic values in connection with present cost figures 
 when the endeavor is to ascertain present value. Such criticism 
 is fair if strict reproduction cost method is being employed, in 
 which case it is better and more logical to determine going value 
 based on an estimate using the revenue of existing plant, as has 
 been done by the Wisconsin Commission for example in the 
 Milwaukee Gas Company case. 
 
 The early deficit method is sometimes unfairly criticized, be- 
 cause if followed, without the limitation of reason and experience 
 
 '"Some Legal Aspects of Regulation of Public Service Corporationa." by Charles F. 
 Matbewsoo, May 11, 1914, page 24.
 
 212 VALUE FOR RATE-MAKING 
 
 as to what are normal conditions, it leads to absurd results, in 
 that an unprofitable business will have greater going value than 
 one that is profitable from the start. As the Court of Appeals of 
 New York has stated: 
 
 "It is urged that an unprofitable business will thus have a greater 
 value for rate-making purposes than one profitable from the start. 
 
 "That again overlooks the fundamental consideration that a public 
 service corporation is entitled to a fair rate of return from the beginning 
 of its investment and no more. If the shareholders have been deprived 
 of a fair return on their investment, because of the time and expense 
 reasonably and properly required to build up the business, they have, 
 to the extent of that deprivation, added to their original investment and 
 are entitled to a return upon it."^ 
 
 Third: — Incoyne. — Going value is sometimes used to mean that 
 value which is derived from a consideration of capitalizing net 
 earnings. 
 
 "It would not have fulfilled its duty had it estimated the sum to 
 be paid in view only of what the lands, buildings, pipes, wires, and 
 other apparatus were worth, considered as separate items. They were 
 to be valued in view of their arrangement for and adaptability to the 
 purposes for which they were provided, and of their earning capacity as 
 a going concern, in ascertaining which special regard was, by the 
 terms of the statute, to be paid for their actual earnings."^ 
 
 While good will is usually not considered an element to be 
 recognized in valuing a public utility that is a monopoly, going 
 value, that is evaluated from a consideration merely of net 
 earnings, is in that sense closely allied to good will, and may 
 perhaps be fairly applied in determining the value of the business 
 of a private corporation but has no place in consideration of value 
 upon which- to base a fair return when considering a public utility 
 corporation operating as a controlled monopoly. 
 
 Value determined from a consideration of net earnings is usually 
 based principally iipon the rate of interest, the" degree of risk and 
 the present and prospective earnings. Therefore, market value 
 resulting ultimately from prospective net returns depends upon 
 rates and, hence, cannot alone be used in fixing those rates. In 
 cases of condemnation for purchase and sale, where rates are not 
 
 ' Court of Appeals, State of New York, in The People ex rel. Kings County Lighting 
 Company V8. Wilco'x el ai:. Composing Public •Service Coiiunission, First District, Mar. 24, 
 1914. 210. N. V. 479. 
 
 ^ Norwich Gas & Electric Co. vs. City of Norwich, 57 All. 751.
 
 aorxa vaijje 213 
 
 under criticism, have not boon sliown to be unfair or porlmps hiivo 
 been approved or authorized by constituted pul^lic authorities, 
 then in such cases the capitahzation of net earnings nmy l>c 
 used as one measure of going value. It would be the difTcrenco 
 between the capitalized amount of the net earnings and the ap- 
 praised value of the physical property, assuming the total valu(! 
 is covered by these two elements. As a matter of fact, the {as- 
 certainment of the two elements, going value and jjliysical 
 property, would be unimportant in case capitalized value alone; 
 is to be accepted as the fair value of the property being con- 
 sidered because the sum of these two elements would equal tlu; 
 capitahzed value. If, however, it is desired to check the capi- 
 talized value by independent methods, the amount of going value, 
 as the difference between the capitalized value and the value of 
 the physical property, should be determined and compared with 
 going value as found by the "deficit" or "comparative" methods. 
 The Privy Council, which generally corresponds to the Supreme 
 Court in the United States, has more than once held that the earn- 
 ings of a property must be considered in determining going value. 
 The Hamilton Gas Company of New Zealand was formed under 
 an act which gave the municipality the right to acquire the 
 property of the gas works, upon paying, to use the language 
 of the statute, what the "gas works and plant" were worth. The 
 lower court found that the commercial value of the "gas works 
 and plant" was, as a going concern, the sum of 31,382£, while if 
 valued in situ, excluding the idea of going value, the property 
 was of the value of only 13,539£. The question involved was, 
 as to which of these two sums should be paid by the corporation. 
 The company contended that the price to be paid for the gas 
 works and plant "should be the commercial value thereof as a 
 going concern," while the Hamilton borough contended that 
 "the price should be merely the value of the gas works ami 
 plant regarded as gas works and plant in situ," and that this 
 value should be arrived at "by taking the present value of the 
 land and buildings and adding thereto what would be the pres- 
 ent cost of the machinery and materials of a similar gas works 
 and plant and of placing such gas works and plant in situ, and 
 making good the ground and deducting the sum for deprecia- 
 tion." The Privy Council held unanimously, ^ Lord Shaw writ- 
 ing the opinion, that the company was entitled to be paid for its 
 
 1 Hamilton Gas Company, Limited, vs. Hamilton Corporation, App. Cae. 300.
 
 214 VALUE FOR RATE-MAKING 
 
 property as a going concern, thereby awarding for going value 
 the difference between £31,382 and £13,539, or £17,834, or, as 
 stated in dollars, approximately S89,215, which is 132 per cent, 
 of the physical value. 
 
 A similar case settled by the Privy Council of England from 
 Western Australia involved the same principle as the preceding 
 case. The City of Perth had, under the law, a right to acquire 
 the property of the gas company at the expiration of six months 
 after serving notice of its intention to purchase from the company 
 
 "all the land, buildings, hereditaments, lamps, pipe, stock and ap- 
 purtenances of and belonging to the company." 
 
 The question was whether, in buying the property, it was to be 
 considered "as a going commercial concern," or whether the 
 company was merely entitled to "the value of the physical prop- 
 erty" in place. The Privy Council reaffirmed its ruling^ of the 
 previous year in the Hamilton case cited above, and held unani- 
 mously that going values must be allowed and that any other 
 construction of the statute would work great injustice. 
 
 In determining rates for competing steam or electric railroads 
 or other utilities, market value, that is, the value fixed from a 
 consideration of earnings, has been used. The Public Service 
 Commission of the State of Washington in finding the value of 
 utility property is required by statute to take not less than 
 market value as to true value of the property. 
 
 "When the commission shall have valued the property of any public 
 service company, as provided for in this section, nothing less than the 
 market value so found by the commission shall be taken as the true 
 value of the property of such company used for the public convenience 
 for the purpose of assessment and taxation. "^ 
 
 As present "fair value" may be more or less than the present 
 "physical value," it is evident that the non-physical or intangible 
 value should be determined in connection with a consideration of 
 revenues. Puljlic authorities when confronted with the problem 
 of fixing rates based on the value of competing utility properties 
 have assumed the same rates for both utilities, and occasionally 
 fixed the rates high enough to earn a return on the larger capital 
 investment, thus recognizing that the going value in the property 
 requiring the smaller capital investment is due to its more 
 favorable showing of earnings. 
 
 ' Perth Gas Company, Limited, va. City of Perth Corporation, App. Cas. (1911) 506. 
 ' Washington Laws, 1911, ch. 117, par. 92.
 
 GOING VALUE 215 
 
 In the Kansas City Water-works case, tlic Supivinc Cuirt 
 said : 
 
 "The city steps into possession of a property which not only has the 
 abihty to earn, but is in fact earning. It should pay, th.-n-fon-. not 
 merely the vakie of a system which might be niade tu i-arn. I.ut that of 
 a system which does earn." 
 
 "The equal protection of the laws— the spirit of (•(.iiiinun j,, slice— 
 forbids that one class should by law be compelled to sulTcr lo.ss that 
 others may make gain. If the State were to seek to acquire the title 
 to these roads, under the power of eminent domain, is there any dowl.t 
 that constitutional provisions would require the payment to the cor- 
 poration of just compensation, that compensation beinir the value of 
 the property as it stood in the markets of the world and not as pre- 
 scribed by an act of the legislature? Is it any less a departure from 
 the obligations of justice to seek to take not the title but the use for 
 the public benefit at less than its market value?"* 
 
 The market value theory as determining the fair basi.s of 
 value for rate-making recognizes those elements inhering in utility 
 property which cost or investment theory may fail to take into 
 account. These elements include favorable location, investment 
 under advantageous market conditions, superior operating man- 
 agement and business methods that produce large revenues per 
 dollar of capital invested. Consequently, market value has 
 many claims for consideration in rate-making and may be well 
 used as a guide and measure in fixing the present "fair value" 
 which ultimately may be determined. 
 
 If rates are to be based on physical cost alone, market value 
 means nothing other than recognition of the rate at which capital 
 is willing to invest, leaving no reward for the opciators of the 
 enterprise. If the rate of return upon the investment is made 
 larger than requirements demand for the safest investment, then 
 the market value will l)e greater than the actual cost. On the 
 other hand, if the rate of return allowed is less than demaiulrd by 
 current capital, then market value v/il! be less than physical cost. 
 It is clear that in a case of a monopoly it is impossible to fi.\ and 
 determine reasonable rates purely from a consideration of market 
 value which is itself determined by the rates. On the other hand, 
 at the time public regulation of utilities is undertaken, it nuiy 
 be that market value is the proper point at which fair present 
 
 1 Reagan vs. Farmers' L & T. Co., 154 U. S. 410.
 
 216 VALUE FOR RATE-MAKING 
 
 value should be fixed as a starting point. There is considerable 
 prevalent opinion that market value is the proper basis in rate 
 cases by which to fix the value even of deteriorated physical prop- 
 erty, that is, property which has become very largely theoretic- 
 ally depreciated or has reached a condition which will soon require 
 renewal. 
 
 Fourth: — Comparison. — Going value is also used to signify the 
 present worth of the excess of earnings of an existing plant com- 
 pared with those of a similar plant, starting anew at the date of 
 the valuation. For lack of a better name and because based 
 on a comparison, this meaning of going value is usually identified 
 by the term "comparative plant" method. This use of the term 
 going value is akin to its use as applied to the deficit method, 
 for both rely on the same fundamental fact for determining the 
 measure of going value, namely, the cost of building up the busi- 
 ness and producing a revenue. In the deficit method, going 
 value is usually fixed by a knowledge of the losses that have 
 actually occurred in the past, in building up the present revenue- 
 producing business; it is a historical method. The comparative 
 plant method is strictly a reproduction method, being an estimate 
 of the cost of reproducing the present revenue of an existing com- 
 pany under present conditions, the same as an estimate of the cost 
 of reproduction of the physical property is made by considering the 
 existing property constructed under present conditions at cur- 
 rent costs. The deficit method of fixing going value and the 
 original cost of physical property are both based on historical 
 investigations, while the comparative method of ascertaining go- 
 ing value and the cost of reproduction of the physical property 
 are based on present costs. 
 
 The comparative method endeavors to fix the deficit that 
 would accrue in building up the business and revenue of a new 
 plant equal to the revenue and business of the existing plant. 
 In determining the amount of this deficit accruing in the com- 
 parative plant, the same period for construction of the physical 
 property and the same other premises are used as are made the 
 basis for fixing proper labor and material unit costs of the phys- 
 ical plant and in determining the length of time during which 
 interest and taxes will accumulate, all of which principles and 
 estimates are ordinarily determined without much controversy in 
 making up the cost of reproducing the physical property. In 
 the same way, based on similar knowledge and experience in
 
 GOING VALUE 217 
 
 existing properties, conclusions are reached as to the period ..f 
 time required to build up the business and revenue. 
 
 Explaining more in detail, it will be seen that to reprochice the 
 revenue of an existing property, it would tirst be necessary lo 
 commence the construction of a physical plant similar in all 
 respects to the existing plant and, thereafter, start lo build up 
 the business equal to the business of the existing jiroperty, a 
 process which would take a considerable period of time. liiu8, 
 the same basis of reproduction cost of the physical piopcrty is 
 used as has been obtained by the engineers nudving an inventory 
 and an appraisal of the existing ph3'sical property. In the re- 
 duction of such physical property there must be assumed a 
 gradual expenditure for land, buildings and apparatus, commen- 
 surate with human limitations, as to the rate at which such 
 property can be specified, purchased, erected and gotten into a 
 condition for operation. This will require some time, at least 
 one open season in smaller plants and several years in larger 
 plants. As soon as sufficient plant has been constructed, it is 
 assumed it would immediately begin operation and service to 
 customers. The completion of the physical plant and the ex- 
 tension of the business go on as rapidly as possible, but as t he- 
 development of business proceeds at a relatively slow rate, the 
 entire reproduction of the physical property will practicall}- al- 
 ways be completed considerablj^ in advance of the accjuisition 
 of the revenue. The rate of acquisition of income is determined 
 from a consideration of the business of the existing company, 
 the rate at which it has been built up, the knowledge of local 
 conditions and experience in the acquisition of business in other 
 similar properties. After a reasonable period, the gross revenue 
 will have been built up to an amount equal. to that of the existing 
 property; in the same way, the operating expenses will gradually 
 have increased until they, too, equal those of the existing com- 
 pany. By comparing the figurx^s of such acquisition of revenue 
 and increase in operating expenses. of the reproduced property 
 with the similar- figures of the existing property, during the period 
 necessarily required for the. reproduction of the physiciil plant 
 and revenue of the reproduced property, the excess earnings may 
 be ascertained. This excess, when ascertained year by year, is 
 then discounted at a current rate of interest, so as to show the 
 value of the excess earnings at the date of the commencement 
 of the reproduction period, that is, at the date^of the commence-
 
 218 VALUE FOR RATE-MAKING 
 
 nient of construction of the physical property, which is taken as 
 the date of the valuation, and the sum of these discounted net 
 earnings of the existing plant — over those of the reproduced 
 plant — is the going value of the existing plant. For a more 
 detailed explanation of this method of determining the going 
 value of an existing plant, the reader is referred to the discussion 
 on going value in the author's book, "The Valuation of Public 
 Utility Properties."^ 
 
 The comparative plant method of determining going value 
 has been criticised because it does not fix a definite ratio be- 
 tween going value and gross revenue or physical property. 
 Such criticism would seem superficial, as the ratio will depend 
 upon specific conditions, for example, revenue and net income of 
 a property will be greater in the case where the investment has 
 been economically made or where the territory has been thor- 
 oughly worked, so as to secure a large amount of business per 
 unit of investment, than in the case where the opposite conditions 
 exist. Again, the investment in an electric plant, producing 
 energy from water-power, will ordinarily he very much larger 
 than for a plant with the same capacity using fuel as the source 
 of energy. As indicating the lack of relation between going value 
 and revenue or property values, the accompanying tabulation 
 is reproduced, showing these values in certain water-works 
 properties, as developed by Mr. John W. Alvord of Chicago. 
 The averages, below the table, have been worked out by the 
 author of this volume, for the eleven cities, indicated by stars, 
 that more nearly compare in population. 
 
 The method has also been criticised because^ it always fixes 
 some going value, greater or less, in all operating properties. 
 But is it not evident that the actual existing business of a going 
 property is always worth something more than the mere physical 
 plant? It would cost something for a new company to secure 
 that same business, even though the gross revenue were only suf- 
 ficient to pay actual operating expenses. Hence, it is impossible 
 for a going property to exist without having some going value, al- 
 though the market value of the entire property, including its 
 going value, in the case of sale, might be less than the present 
 depreciated value of the physical property alone. The non-suc- 
 cess of a utility as a paying property docs not demonstrate there 
 is no going value any more than the existence of such property 
 
 1 See page 152, "The Valuation of Public Utility Properties," by Henry Floy.
 
 GOING VALUE 
 
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 220 VALUE FOR RATE-MAKING 
 
 demonstrates the ph^-sical plant is worth what it may have cost 
 or what it may now appraise for. An investor will always be 
 willing to pay a bonus for an established business as compared 
 with buying the structural property without such business, be- 
 cause in the latter case it will cost something additional to create 
 an established business. The total price the investor will be 
 willing to pay for the structural property, plus the established 
 business,* is only such as will afford him a satisfactory return, 
 present or prospective; consequently, the value to him may or 
 may not be greater than the original investment or the appraised 
 value, depending upon the revenue obtainable and the cost of 
 operation, but in any case some part of the total value is rep- 
 resented by going value. 
 
 The comparative plant method has been criticised because 
 the results "rest upon certain basic assumptions as to the rate of 
 construction of the physical plant, the rate of recovery of the 
 earnings, and the rate of increase of operating expenses."* 
 There is no question but what the method rests upon "certain 
 basic assumptions," the result of expert opinion, but where 
 assumptions are based on reliable expert opinion, the courts have 
 held the conclusions reached are a safe basis upon which to fix 
 values. The assumptions made as to the rate of construction of 
 the physical plant are the same as those used in ascertaining the 
 cost of reproduction of the physical property, which is not 
 generally criticised, at least as to principle. The rate of recovery 
 of earnings can be fairly definitely established for any particular 
 property by a study of local, historical conditions and a knowledge 
 of the experience of similar plants. The rate of increase of 
 operating expenses can be very definitely determined when the 
 rate of recovery of earnings is fixed and from a knowledge of the 
 output and analysis of the existing operating expenses. 
 
 At first thought it would seem as if the comparative plant 
 method was used to "argue in a circle," in that present revenues, 
 based on existing rates, are employed in order to determine the 
 going value of part of the principle upon which fair return is to 
 be allowed. To a limited extent this criticism is fair, but it will 
 be easily recognized that if the existing rates are assumed to be 
 excessive by some arbitrary amount, say 10 per cent, or 20 per 
 cent., the total revenue of the existing plant can be reduced by the 
 amount of the arbitrary percentage assumed and going value 
 
 ' City of Greenbay vs. Greenbay Water Company, 11 W. R. C. R. 245.
 
 GOING VALUE 221 
 
 figured on that basis. Such proccchnc will ordinarily show that 
 the amount of going value determined by the use of the existing 
 rates is but little in excess of the going value as found l)y arbi- 
 trarily reducing the revenues a moderate amount. In fact, 
 going value will be found to exist in a very substantial amount [ 
 with the ordinary property, even though, as an extreme; assump- 
 tion, revenues are assumed and taken to be only such an amount 
 as will provide for operating expenses including taxes and depre- 
 ciation and a fair return on the value of the physical pioix-rty. 
 It must, of course, be recognized that the comparative plant 
 method is to be used fairly and logically in assisting the judg- 
 ment to determine a reasonable amount for going value; the 
 method cannot be applied without sense or reason, merely as 
 a mathematical performance, in working out to the last decimal 
 point a figure which, beyond controversy, can be held as an abso- 
 lute measure of going value. 
 
 Criticism of the comparative plant method has been made un 
 the grounds that with the physical property entirely complete, 
 the business of the customers and revenue of the utility would 
 immediately be attached and developed. As a practical matter 
 such is not the case. To any one unacquainted with the details of 
 utility business, the rate of development is surprisingl}' slow and 
 the lethargy and antipathy of the non-user is incomprehensible^ 
 although, of course, much depends upon the character of the local 
 community. It is difficult for the uninitiated to conceive of a 
 city without a public water supply, for example, where the addi- 
 tion of consumers and the development of the business would not 
 be practically as rapid as the progress of construction of the 
 physical property. But such is by no means the case even with a 
 utility providing such a necessity as water, and in the case of 
 utilities furnishing transportation, gas or electric energy, the 
 development of the business is very much less rapid than in the 
 case of water. A most excellent illustration of this truth is 
 shown by the history of the installation and development of the 
 city water-works system in New Orleans, La. This city now 
 has a population of 360,000, but in 1908 it had no public water- 
 works system of its own and only an inadequate, privately 
 owned plant, in the hands of a receiver. The construction of the 
 city's waterworks was begun in 1905 and sufficiently completed 
 three years later to begin furnishing WMter, the sui)i)ly of 
 water being taken from the Mississippi River. Up to that
 
 222 VALUE FOR RATE-MAKING 
 
 time the citizens were depending largely upon tanks in which 
 rain water was stored or in some comparatively few instances 
 upon wells. The city has constructed a complete modern water- 
 works system at an expense of approximately $9,000,000, in- 
 cluding pinnp works, equipment for sedimentation, coagula- 
 tion and filtration, a distribution system containing 547 miles of 
 pipes covering the populated districts, and the property is now 
 in a position to supply all demands with a first class quality of 
 water. In spite of the construction of the new municipal works 
 and the availabilitj^ of a copious supply of potable, pure water 
 the citizens did not connect their premises and in order to compel 
 the citizens to take water from the municipal system promptly, 
 an ordinance was adopted by the authorities on July 13, 1911, 
 under which the Water Board was given authority to notify 
 individual householders that they must connect with the water- 
 works system within 90 days of the said notice, and in case of 
 failure to complj^ with said notice the property owner was subject 
 "to a fine not exceeding $25, or to imprisonment not exceeding 
 thirty (30) days, or both, at the discretion of the Court, for each 
 day thereafter." In case of continued default, upon further 
 written notice requiring compliance within 10 days additional, 
 then the Board was given power "to do, or cause to be done, 
 upon the defaulting premises, that which its ordinances and 
 regulations require, at the cost and expense of the owner, and 
 such cost and expense shall be a lien on said premises equal in 
 rank to the lien of the taxes, to take effect as to third persons on 
 the recording in the Mortgage Office of the bill therefore, * * *." 
 This general line of procedure has been duly followed since, 
 with the result that, in round numbers, 67,000 buildings have 
 been connected out of the total 75,000 buildings now estimated 
 in the City of New Orleans. In connection with this matter, a 
 statement from the report of the General Superintendent, Mr. 
 Earle, submitted to the Board Oct. 14, 1915, is of interest: 
 
 "Forced Connections. — Continued progress has been made in serv- 
 ing of notices on property holders to connect with the sewerage and 
 water-works systems. To date a total of 7,556 notices have been 
 served, of which 6,038 have been complied with, and 168 on which the 
 90 days limit of time has not yet expired." 
 
 The unwillingness of the citizens to take pure water exists 
 despite the local conditions, namely: 
 
 First. — The large number of buildings supplied only from
 
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 (Betwetn JtaipiB 222-12S
 
 aOINd VALUE 22:i 
 
 tanks or cisterns witli rain water of nnceitaiii purity arni varialdc 
 in amount. 
 
 Second. — The desirability of doin^ away with tanks aixl 
 cisterns, which very lar^jely contributed to the continuatiun nf 
 the annual plague of yellow fever which formerly i)revailcd in New 
 Orleans. 
 
 Third. — The attractiveness and healthfulness ot a niuinripid 
 supply of first class water at reasonably low rates. 
 
 Fourth. — The local strong sentiment favoring the use of water 
 supplied by the municipality and demanding; cooperatinii .iii.I 
 support of a great public work. 
 
 Fifth. — The active enforcement of the ordinances and 
 regulations providing for the connection of each and every liouse 
 in the City with the municipal water supply. 
 
 The surprising tardiness and natural reluctance of the average 
 citizen to change his existing mode of living, is completely 
 evidenced in the record shown by the curves on the follow- 
 ing page, indicating the slow progress made in substituting a pure 
 and copious supply of water for the old sources of supply. The 
 growth of the business, shown by the accompanying curves, re- 
 produced from a diagram in the annual report of the Sewerage 
 and Water Board of New Orleans, for the year ending Jan. 1, 
 1915, extended to 1916 by the writer, from data secured from 
 the Department, indicates the growth of the business by the 
 number of services and meters each year, from the time the water- 
 works began supplying water in July, 1908, up to the present 
 time. It will be noted that the number of services in use has 
 increased at a very uniform rate and that the completed construc- 
 tion of the physical plant and its ability to supply water to all 
 users, has not had very much to do with the rate at which the 
 consumers are willing to take up with a new proposition and use, 
 even so necessary a commodity as water. 
 
 The total house connections, including fire services, up to Jan. 
 1, 1916 were 41,037, that is, one connection for 8.8 inhabitants 
 compared, for example, with 8.2, found by the Wisconsin Com- 
 mission, as an average for Wisconsin towns. By reason of the 
 difference in conditions existing before and after the city water- 
 works was built, and because of the existing ordinance requiring 
 the taking of city water, it would seem as if a water-works system 
 in New Orleans, if anywhere, would show a very rapid increase 
 in the number of consumers and yet the contrary is the fact.
 
 224 
 
 VALUE FOR RATE-MAKING 
 
 The reluctance of the average citizen to become the user of 
 public utility service is almost inexplicable, and has been the 
 cause of frequent and calamitous loss to investors in public 
 utility corporations. The following table, giving the actual 
 results obtained in certain water-works properties is pertinent. 
 
 Table VII. — Showing the Time Required for Water-works Plants 
 TO Acquire One Dollar per Capita of Domestic Revenue 
 
 Prepared by the late Mr. Benezette Williams. (From Proceedings of the American Water- 
 works Association, 1909, page 250.) 
 
 Domestic revenue in 
 dollars and population 
 
 Years to acquire one 
 dollar per capita 
 
 Appleton, Wis 
 
 Eau Claire, Wis. . r-. . 
 
 Sheboygan, Wis 
 
 Galena, Kansas 
 
 Hornelsville, N. Y... 
 
 Flint, Michigan 
 
 Dubuque, Iowa 
 
 Beloit, Wis 
 
 Ludington, Michigan 
 
 Warren, Ohio 
 
 Salina, Kansas 
 
 16,700 
 
 18,000 
 
 20,000 
 
 4,700 
 
 11,000 
 
 10,200 
 
 36,300 
 
 9,000 
 
 8,000 
 
 7,200 
 
 5,.500 
 
 21 
 
 15 
 
 6 
 
 8 
 
 29 
 12 
 
 10 
 7.5 
 
 12 
 
 Unwarranted presumptions sometimes made by public utility 
 commissioners or judges of court that the "comparative plant" 
 method of estimating going value is "guess work," "mere opin- 
 ion," "unreliable estimates," etc., are in many cases entirely 
 unwarranted and indicate a lack of appreciation of the compli- 
 cated facts, data and experience necessarily included in making up 
 such estimates which are in most cases based upon a knowledge of 
 conditions in similar or like plants, modified by the judgment of 
 the expert in its application to the existing conditions. 
 
 The comparative plant method has been criticized because it 
 takes into account the business of the existing plant in the im- 
 mediate future. But such criticism would seem unfair because 
 the estimate of the business in the immediate future is based on 
 the facts as to the immediate past. Moreover, it would be illog- 
 ical to determine present going value upon the assumption that 
 the value should have been anticipated by a period of years. 
 For example, if a city is purchasing property as of Jan. 1, 1916, 
 and going value is figured as of that date, it would be illogical to 
 assume that the city might have begun building the comparative
 
 GOING VALUE 
 
 225 
 
 property five or six years earlier, before any decision \v;is made t(. 
 own such property, and accept such vahie ns prcjpcr prcs^cnt 
 going value. The question is whether the property was to ho 
 taken as of Jan, 1, 1910, and if so, what the city couhl afTord to 
 pay on that date, not what they could afford to pay if they had 
 decided several years previously to purchase that projMTty. 
 Moreover, the dating back of going value would not very materi- 
 ally reduce the amount of same, as it would be effected only l)y 
 the increase of future revenue over the present, which increase is 
 usually a relatively small percentage of the existing revenue. 
 
 A modification of the deficit and comparative i)lant methods 
 has been used by the Railroad Commission of Wisconsin, and 
 was first published in the decision in the Milwaukee Gas Light 
 Company case. The method consists, in general, in using 
 such value of the physical property to start with as is estimated 
 to be required to begin furnishing service and, from year to 
 year, adding to such property value, additions, allowance for 
 fair return, operating expenses and the necessary amount for 
 depreciation, then deducting from the sum the annual revenue, 
 thereby getting a value which is called plant value that repre- 
 sents the total cost of plant and business at the end of each year. 
 If from this cost of plant and business, as found for any year, there 
 is deducted the value of the physical plant and its additions 
 at the end of such year, the result is the cost of development of 
 the business up to the end of that year. 
 
 Table VIII. — Cost of Development of Business^ 
 
 Milwaukee Gas Lij^ht Company. 
 
 1 1st year 
 
 2n(l year 
 
 3rd year 
 
 4th year 
 
 Cost of plant, January 1st 
 
 Additions 
 
 $9,000,000 
 500,000 
 630,000 
 17,.500 
 660,000 
 160,000 
 
 $10,005,220 
 300,000 
 700.365 
 10,500 
 989,000 
 170,000 
 
 $10,498,385 
 
 250,000 
 
 723,887 
 
 8.750 
 
 1.131,000 
 
 180,000 
 
 $10,688,922 
 100,(XX) 
 748.225 
 
 Interest on additions for \i year. . 
 
 3.. 500 
 1.265,400 
 
 Depreciation 
 
 190,000 
 
 Total cost 
 
 $10,967,500 
 962,280 
 
 $12,175,085 
 1,676,700 
 
 $12,803,022 
 2,114.100 
 
 $12,990,047 
 2.414,250 
 
 
 
 Plant value, Dec. 31 
 
 $10,005,220 
 
 $10,498,385 
 
 $10,688,922 
 
 $10,581,797 
 
 Cost of developing business end 
 of year 
 
 505,220 
 1,320,000,000 
 
 698,385 
 2,300,000,000 
 
 638.922 
 2.900,000,000 
 
 431.797 
 3.330,000,0<X) 
 
 
 
 iCity of Milwaukee vs. Milwaukee Gas Light Co., 12 W. H. C. K. 402. 
 15
 
 226 VALUE FOR RATE-MAKING 
 
 As seen by reference to the accompanying table, the plant value 
 as found at the end of the first year is carried forward as the 
 value of the property at the beginning of the second year, to 
 which amount the value of additions to structural property, 
 fair interest charges, operating expenses, necessary allowance for 
 depreciation are added and from the sum is deducted the esti- 
 mated annual revenue for the second year, thus getting the total 
 cost of plant and business at the end of the second year; deduct- 
 ing from this sum the total cost of plant and its additions up to 
 the end of that year, the remainder will be the cost of develop- 
 ment up to the end of the year. The property cost at the end 
 of the second year is then carried forward and forms the base to 
 which are added the additions and charges for the third year, 
 with deduction for gross revenue. This process is continued for 
 several years, usually from four to six years, covering a period 
 in which it is estimated the business can be built up to a point at 
 which, under normal conditions, revenues are sufficient to pro- 
 vide a fair return upon the property, as well as depreciation and 
 operating expenses. From the property value, as found for the 
 last year, is deducted the total value of plant and additions, the 
 remainder being the cost of developing the business at the time 
 the property is assumed to be upon a paying basis, and therefore 
 the said cost of development represents the going value which 
 must be added to the value of the plant in order to ol)tain the 
 total value of the property, since interest during construction is 
 included in the value of the physical property, and all operating 
 expenses, including taxes and depreciation, together with a fair 
 return on the entire investment are cared for in the computation 
 made along the above lines. Criticism of this method, the same 
 as of the strict comparative-plant method, may he made on the 
 grounds that actual revenue in place of "fair revenue" is used 
 in the calculations. It has been suggested that the criticism 
 can be avoided by substituting x for the final ''fair revenue" 
 and a fraction or percentage of x for the different preceding 
 years, then solving for x, which when found and capitalized at 
 the "fair rate of return" assumed will give the actual fair value 
 of the entire property, including going value. 
 
 It will be seen the above method of estimating going value 
 which has been used and apparently approved by the Wisconsin 
 Commission is, like the comparative plant method, based on the 
 value of the plant, assumptions as to the time required for its
 
 GOING VALUE 227 
 
 construction, interest charges, taxes, estimates as to growth and 
 development of the business and revenue extending over future 
 period of time considered necessary to put the property on a 
 basis where it will earn all operating expenses, depreciation 
 allowances and a fair return. 
 
 In addition to the Wisconsin Commission, the Railroad Com- 
 mission of California has approved the use of the comparative 
 plant method in the following language: 
 
 "The engineers for the defendant have estimated a 'going concern 
 cost' or 'development expense' for this system amounting to $212,100. 
 The computation by which this is derived assumes building an identical 
 plant and is derived by the following method, as set out in the engineers' 
 report : 
 
 'The sum of the annual excess in net returns of the existing plant over 
 the comparative plant, in the period of years from the taking to the time 
 when the earnings of the comparative plant are assumed to become 
 identical with those of the existing plant, represents the development 
 expense of the existing plant.' 
 
 "If applied to a fair period and based on accurate data, this method 
 becomes an approximate measure of the amount of losses sustained in 
 bringing the plant to a paying basis. "^ 
 
 The Supreme Court of Wisconsin has recently rendered a pecu- 
 liar decision in which it took the position that the value of the 
 property of the Oshkosh Water-works Company as found by the 
 Wisconsin Commission at $525,000 was correct, on the ground 
 that: 
 
 "One thing is evident. The Commission either allowed $54,000 for 
 reproduction cost of paving not disturbed, and about $14,000 for going 
 value in their final award, or else they disregarded the item of $54,000, 
 and allowed $68,000 for going value. 
 
 "An ehmination of the item $54,000 results, as before stated, in an 
 allowance of about $68,000 for going value. Under the evidence such 
 sum is reasonably adequate. If the Commission erred in allowing only 
 $14,000 for going value, such error was cured by its allowance of $54,000 
 for reproduction cost of paving not disturbed. If it did not allow the 
 $54,000 item, then it allowed $68,000 for going value. In either case the 
 plaintiff was not prejudiced.'"' 
 
 ' Report of decisions of the Railroad Comrnission of California, Thonias ^^onahatl, as 
 Mayor of tiie City of San Jose vs. Sao Jose Water Company, Case No. 470, decided May 
 22, 1914 (Decision .No. 1534. pages 14 and lo). 
 
 ^Oslikosh Water-works Co. vs. Railroad CommissioD of Wiscopsin, 152 .N. W. 859, 
 R. U. R. 1915, D 342, 4.
 
 228 VALUE FOR RATE-MAKING 
 
 Going Value not Plant Operation. — The term "going value" 
 is sometimes used in ignorance or disingenuous!}' to indicate 
 that the physical plant is working and going in the sense that the 
 physical elements are performing the functions for which they 
 were installed. This latter adaptation of the term "going" to 
 the physical plant is entirely misleading and, as is evident, no 
 additional value above the cost of complete construction, accrues 
 to the structural property, pei' se, simply because the machinery 
 is in motion and the plant used instead of being allowed to re- 
 main inactive. Considering a new property the cost of the 
 physical plant complete before operation began would be iden- 
 tical with the fair present value of the same plant the following 
 day when it was put into full operation if going value means 
 nothing more than operation. 
 
 Some authorities have used going concern as distinct and sepa- 
 rate from going value, apparently indicating by going concern, 
 the fact that the plant is in operation and therefore going con- 
 cern would mean the same as going value under the erroneous 
 definition of the preceding paragraph. Going concern and going 
 value arc usually intended to cover the same item of property 
 value, namely, that intangible element, not being represented by 
 physical property, which results in addition to, but in connection 
 with the structural property when the latter is being used so as 
 to yield a revenue. 
 
 Going value as meaning nothing more than the operation of 
 the physical propert}' has been definitely and specifically urged 
 by public authorities and is disapproved by courts. A very re- 
 cent case of this kind is. that of the Kings County Lighting Com- 
 pany, where the Public Service Commission of New York, First 
 District, speaking through its chief counsel says: 
 
 "Aside from earning power; however,- one may not doubt that in 
 a rate case the Inisiness or the plant in which the several parts have 
 been gathered together, in orieplace, connected aiid put in operation, 
 may have value. It is assumed, of course, that the operation is not 
 merely experimental and that the business or the plant has been gathered 
 not in a wihlerncss but in some place where there is demand for its 
 service. If this be not the fact, then the business or the plant is not 
 worth, even its construction cost and may possibly have no value 
 whatsoever. Giving the plant any value implies necessarily that it is 
 working and going to some extent. "^ 
 
 ' Brief of Hon. Goo. S. Coleman, Counsol of the Public Service Commission, of the First 
 Distriit, before tlie Court of Appeals, in the State of New York, page 27.
 
 GOING VALUE 229 
 
 The eminent counsel in this case apparently fails to appreciate 
 the difference between "the business" and "the plant." Evi- 
 dently he would not allow any value to a physical plant which 
 had been newly completed ready for business but had never 
 turned a wheel because he says, "Giving the plant any value 
 implies necessarily that it is working and going to some extent." 
 This attitude of mind of counsel, supports the opinion of the 
 Commission in the same case, as shown by the following state- 
 ment: 
 
 "Throughout the appraisal the plant has been treated as a 'going 
 concern.' The property has not been valued as a defunct or static 
 concern. If it had been, the value would be very much lower than the 
 amount fixed. "^ 
 
 It would be interesting to know what difference in value this 
 or any other commission would make, between the value of a 
 newly completed "static" plant, and that same plant "going." 
 It will be noted that "going concern" is used in connection with 
 the physical property whereas the term properly relates to the 
 business and the establishment of revenue which is entirely dis- 
 tinct from the construction of a structural plant. 
 
 The Public Service Commission of the State of Missouri, in a 
 recent decision, has fallen into the same error, stating: 
 
 "The Commission will not attempt to fix a separate and distinct 
 item for going value in this case, as contended for by defendants, but 
 will take 'into account, the fact that the plant was in successful opera- 
 tion' as a going concern. "^ 
 
 The attitude of certain public authorities in declining to allow 
 a separate item for going value is, no doubt, in part due to the 
 loose use of the term "going value" and "going concern value" 
 by the courts, the contrary opinions and decisions of judges and 
 courts themselves, due to failure to understand all the elements 
 that go to make up utility property. 
 
 Going value is just as definite and essential a part of the cost 
 of establishing the revenue, as is engineering, lawyers' fees, in- 
 terest on investment, taxes, etc., a part of the cost of establishing 
 physical property of a public utility. 
 
 ' p. S. C. R. of New York, First District, Vol. II, page 694. 
 
 "^ Decision of Public Service Commission of the State of Missouri, rendered June 23, 1914, 
 McGregor-Noe Hardware Company et al. vs. Springfield Gas & Electric Co. etc., Reports 
 Vol. I, page 526.
 
 230 VALUE FOR RATE-MAKING 
 
 Both the Supreme Court and the Higher Court of Appeals, 
 of the State of New York, have definitely negatived the claim of 
 the Public Service Commission of New York, First District, and 
 its counsel, that: 
 
 "going concern value as a separate item in tlie valuation of a property 
 in the rate case was not to be ascertained, allowed and added to the 
 value of the structural property."' 
 
 Judge Clark, quoting with approval the Supreme Court's de- 
 cision in the Omaha Water Company, the National Water-works 
 Company, Knoxville W^ater-works Company, and the Cedar 
 Rapids Gas Company cases, and others, held that the New 
 York Commission's decision showed on its face it had not prop- 
 erly allowed for going value in determining fair value, simply 
 because the physical property was being used rather than allowed 
 to stand idle. The Commission's basis of considering going 
 value does not add one dollar to the cost of the physical prop- 
 erty, completed and ready for service, whereas it is common 
 knowledge that it costs additional time, effort and money to 
 obtain business and produce a revenue. This fact is clearly 
 recognized by Judge Miller of the Court of Appeals, which court 
 sustains Judge Clark's decision, and passing on the method 
 followed by the Commission says: 
 
 "The Commission in this case says it was taken into account in 
 valuing the plant as a 'going' and not a 'defunct' or 'static' concern 
 and that it was also considered in fixing the fair rate of return. The 
 Appellate Division says that there is no proof of the latter fact in the 
 record. Thus the first question certified required us to decide whether 
 'going value' is to be appraised as a distinct item, or whether it is 
 sufficient to regard it as something vague and indefinable to be given 
 some consideration but not enough to be estimated. The valuation of 
 the physical property was determined by ascertaining the cost of re- 
 production less accrued depreciation. Preliminary and development 
 expense prior to operation were included, but no allowance was made 
 for the cost of developing the business. By tliat metliod, the plant 
 was valued in a sense as a 'going concern,' in other words, 'scrap' 
 values were not taken; but to say that that sufficiently allows for 
 'going value' is the same as to saj' that 'going value' is not to be 
 taken into account." 
 
 * * * "It would have been entitled to a return on the valuation 
 adopted by the Commission if it had no customers, but was just 
 
 ' Brief of Hon. Geo. S. Coleman, Counsel of the Public Servioe Commission of the First 
 District, before the Court of Appeals in the State of New York, page 27.
 
 GOING VALUE 231 
 
 ready to begin business, whereas it had a plant in operation witli an 
 established business, which every one knows takes time, lal)or and 
 money to build up." * * * 
 
 "Manifestly a rate computed on the cost to-day, reproducing the fair 
 j)lant would not be fair. Experience is proverbially expensive." * * * 
 
 "The term 'going value' though not exactly defined, has been used 
 quite generally to comprise the elements not included in the structural 
 value of the property in its present condition. The term is not im- 
 portant. The point is that in some manner and under some property 
 heading a due allowance must be made for the investment in tliose 
 elements. "1 
 
 Going Value not Rate of Return. — Some theorists argue that 
 going value cost should be paid off out of earnings and not allowed 
 as a part of the capital value of the property. Such procedure is 
 desirable where practicable, as would be the logical carrying out 
 of that theory to its fair conclusion, namely, that the cost of the 
 physical plant should also be paid off out of earnings so that the 
 entire utility property would have no outstanding value and 
 rates could justly be fixed by being based only upon operating 
 expenses, including management, taxes and depreciation. Such 
 regulation will absolutely "safeguard the actual investment of 
 the security holders and reduce the cost of production and the 
 rate of charge." 
 
 The trouble with these theories is that while they may be ideal 
 they are impracticable. This is well illustrated by the following 
 arguments advanced in a recent paper. - 
 
 "The better way is to forego dividends until earnings are adequate 
 to cover ordinary operating expenses, cost of securing new business, and 
 interest on bonds. * * * Public policy with relation to public utility 
 rates cannot be limited by an estimate of cost to a particular consumer 
 at a particular moment. Public policy will look to the future as well 
 as to the present and adopt the rate policy that offers the largest 
 measure of public advantage even though the chief advantage be secured 
 by future consumers rather than by those of the present. The rate- 
 paying public can well afford to bear the temporary extra cost of 
 amortizing all intangible and questionable elements of capital cost. 
 This will tend to safeguard actual investment of the security holders 
 and to reduce the cost of production and the rate of charge." 
 
 1 Court of Appeals, State of New York, in The People ex rel. Kings County Lighting 
 Company vs. Wilcox et at, composing Public Service Commission, First District, Mar. 24, 
 1914, 210 N. Y. 479. 
 
 ^ "Principles of Valuation" by R. H. Whitten, The Annals of American Academy of Political 
 and Social Science, May, 1914, page 194.
 
 232 VALUE FOR RATE-MAKING 
 
 Under ordinary circumstances, investors cannot be induced 
 to tie up their capital with the expectation that they shall be 
 compelled to go without earnings in order to amortize any 
 considerable part of the investment necessary for creating the 
 property and "forego dividends until earnings are adequate to 
 cover operating expenses, cost of securing new business and 
 interest on bonds." The return upon capital is not and cannot 
 be controlled by arbitrary rules. Free capital cannot be com- 
 pelled to invest by statute. Unless regulating bodies recognize 
 the economic laws which control the local rate of return demanded 
 })y investors, free capital cannot be induced to enter the particular 
 enterprise under consideration. If investors are to be forced to 
 go witiiout their dividends in order to amortize some part of the 
 proper capital cost of the enterprise, such enterprise will ordinarily 
 not be financed. If rates are made sufficiently high in the 
 early history of the average utility to provide in addition to 
 operating expenses and dividends, an amount sufficient to amor- 
 tize the cost of creating the business, then the rates will usually 
 be so high as to reduce business to such a point as to jeopardize 
 the success of the entire enterprise. The history and records 
 of utility corporations show that it is utterly futile to expect that 
 "the rate-paying public can well afford to bear the temporary 
 extra cost of amortizing all intangible and questionable elements 
 of capital cost." There is no reason why the future, as well as 
 the present users should not pay a return on the capital properly 
 expended in creating the business the same as they are expected 
 to do on the capital invested in the establishment of the physical 
 property. If regulating bodies desire to have the cost of estab- 
 lishing the business amortized, and will make the futvn-e rates 
 sufficiently high to cover this amortization, as well as pay operat- 
 ing cxix'nses and dividends the owners cannot object to such 
 procedure, but because the owners have not amortized such costs 
 in the past is no reason for arbitrarily reducing capital investment 
 by such sum. If the capital necessary to expend in building up 
 the business and revenue were customarily provided by the sale 
 of securities, rather than by inclusion in operating expenses, 
 probably regulating bodies would not fall into the error of con- 
 cluding that the money sacrificed by the investor in the form of 
 dividends docs not belong to him, any more than they would if 
 he had invested a like amount as original capital. It has been 
 held Ijy some few authorities, notably the Public Service Com-
 
 GOING VALUE 233 
 
 mission, First District of New York, that "going value" has been 
 included and allowed for, when instead of capitalizing early- 
 losses incurred in establishing a revenue there is allowed a "some- 
 what higher rate of return in later years." As will be recog- 
 nized, this is a very crude way of approximating justice. A 
 "somewhat higher rate in later years" is very indefinite and 
 may, or may not, cover the early losses, the existence of which 
 in connection with developing, or attaching the business to 
 the physical property is generally undisputed. That this 
 theory is wrong in principle is recognized by a large number 
 of courts and commissions, notably the Wisconsin Commission, 
 which has always ruled contrary to any such theory, and, 
 as shown above, the Court of Appeals of the State of New 
 York, affirming the rulings of the lower court, expressly dis- 
 approved any such theory of going value and recognized that 
 going value should be included as a separate part of the capital 
 investment. Such procedure permits a more equitable charge 
 for service during the early days when revenue is likely to be small 
 and charges for service relatively high. 
 
 "To view the matter in another aspect, take the case of a public 
 service corporation with a plant constructed just ready to serv-e the 
 pubUc, It is going to take time and cost money to develop the highest 
 efficiency of the plant and to establish the business. Three courses 
 seem to be open with respect to rate-making, viz.: 1, to charge rates 
 from the start sufficient to make a fair return to the investor and to 
 pay the development expenses from earnings, a course likely to result in 
 prohibitive rates except under rare and favorable circumstances; 2, 
 to treat the development expenses as a loss to be recouped out of earn- 
 ings, but to be spread over a number of years, in other words, as a 
 debt to be amortized, that involves complications, but would seem to 
 be fairer to the public and certainly more practical than the first; 3, 
 to treat the development expenses, whether paid from earnings or not, 
 as a part of the capital account for the purpose of fixing the charge 
 to the public. The last course would seem to be fairest to both the 
 public and the company, as well as the most practical."^ 
 
 As is usual in the ordinary and normal course of business, if a 
 utility property is not a paying one at the start, the investors are 
 to that extent deprived of that to which they are equitably 
 
 1 Court of Appeals, State of New York, in the people ex rel.. Kings County Lighting 
 Company vs. Wilcox it al., composing Public Service Commission, First District, Mar. 24, 
 1914, 210 N.Y. 470.
 
 234 VALUE FOR RATE-MAKING 
 
 entitled, and, hence, are involuntarily compelled to reinvest the 
 amount of such deficiency. To hold that investors are not 
 entitled to interest upon this portion of their added, but more or 
 less involuntary investment, is equivalent to saying that they 
 may be deprived of a portion of their investment without due 
 compensation.
 
 ('itapt1':k IX 
 
 DEPRECIATION 
 
 General Discussion. — Any utility that has onco gotten fairly 
 started must include in its operating expenses certain items to 
 cover the cost of renewing the exhausted physical parts. Where 
 the cost of the individual parts renewed is a relatively insig- 
 nificant part of the total operating expenses and where the life 
 of tluise exhausted parts is relatively brief — for a few weeks, a few 
 months or, at most, a year or two — the expenditures are included 
 as a part of operating expenses under the head of "wear and 
 tear" or "maintenance" without controversy. In the matter 
 of such items th(!re is seldom, if ever, any discussion or contro- 
 versy with regard to ignoring their cost or value in ascertaining 
 the present fair value of existing property, no deduction from 
 cost new usually being made for "wear and tear." 
 
 On the other hand, as to those elements of property that cost 
 relatively large amounts, or last a number of years, there is wide 
 divergence of opinion as to the proper method of handling the 
 costs and providing for the expenditures necessary when renewing 
 the elements, and equal difference of opinion as to whether or not 
 theestimated, accruing amount of tlepreciation should be deducted 
 from cost new in ascertaining present value. It will be seen that 
 the reason for the difference in opinion as to this matter of accru- 
 ing reduction in remaining usefulness of physical property de- 
 pends primarily upon the arbitrary division of tinu; adopted for 
 convenient accounting. If public utilities, instead of making 
 annual reports, were accustomed to make reports only once in 
 25 years, the so-called depreciation question would probably 
 never have arisen, as affecting the basis of rate-making, because 
 most or all charges on account of renewals and rejilacemtMits (the 
 life of so many physical elements having a life of less than 25 
 years) would then become merely maintenance and, like the 
 other items of wear and tear, be taken care of in the gross oper- 
 ating expenses for the 25-year period. 
 
 235
 
 230 VALUE FOR RATE-MAKING 
 
 "So we see the capital expenditures, as distinguished from expenses, 
 are at last an arbitrary conception. It begins with the idea that certain 
 expenditures have an efficiency which reaches over manj' earning periods 
 extending indefinitely into the future. But nothing physical would 
 last so long, and its earning power might even have less permanence. 
 To meet this condition we arbitrarily designate certain expenditures 
 whose affect indefinitely outlasts the immediate earning period as 
 'capital,' and then in the same arbitrary way, through all subsetjuent 
 vicissitudes, we hold them to their first value by maintenance, renewal 
 and depreciation charges, which are borne by other expenses. "^ 
 
 If this fundamental fact were generally appreciated, that the 
 division of time in the life of utility property is divided into 
 monthly and yearly periods for purposes of accounting conven- 
 ience, it would be easily realized that charges for depreciation 
 are merely provision for accruing maintenance. These expendi- 
 tures must be deferred, because neither good business nor effi- 
 ciency permit such expenditures for accruing wear and tear until 
 such time in the future as renewals are required. 
 
 Considering a utility having many physical elements, which is 
 neither extending nor contracting its property, in a town in which 
 real estate values are at a standstill, the depreciated value of 
 such property, neglecting scrap values, is approximately 50 per 
 cent, of its cost new. The reason so many appraisals that take 
 into account accruing depreciation result in a value as high as 
 ordinarily found, from 75 per cent, to 85 per cent, of cost new, 
 is due primarily to the fact that in America practically all utili- 
 ties are constantly adding and enlarging their physical plant, so 
 that the property, as a whole, is not in a normally depreciated 
 condition. Where extensions and additions to original property 
 are not being made, there will be found items of physical plant 
 and ec}uipment in all stages of life from new to that just ready 
 to be discarded; consequently, every plant which consists of a 
 large number of units and has been operated for sufficient length 
 of time to have every element replaced one or more times, will be 
 found approximately in a 50 per cent, theoretical depreciated 
 condition, that is, on the average the property will be half worn 
 out, although, if properly maintained, as useful as if new and 
 rendering 100 per cent, service value. The statement of this 
 general principle was first published by the writer in a paper on 
 "Depreciation" read before the American Institute of Electrical 
 
 ' Handbook of Jiuilroud Kxpcnsos, J. S. Eaton, pjige .'J.
 
 DEPRECIATION 237 
 
 Engineers in June, 1911. It has also been more fully explained 
 by him elsewhere/, and elaborated by Mr. Jas. E. Allison 
 and others. 
 
 Therefore, if accruing depreciation is taken into account in 
 fixmg the basis of rates, the present depreciated value of almost 
 any large property, that is not expanding or contracting, and in 
 which the value of real estate is but a small percentage of the 
 whole, can be obtained by simply cutting the cost of reproduction 
 new in half and adding 5 to 10 per cent, to cover scrap or salvage 
 value. 
 
 Take, for example, a large steam railway system. It would 
 probably be admitted without very much argument that the ties 
 are in all conditions between the new ones that may have been 
 installed yesterday and the worn out ones which are to be taken 
 out to-morrow, so that, as their scrap value is zero, their present 
 theoretical depreciated condition must be 50 per cent, of their 
 total cost new. It would probably be admitted, without argu- 
 .ment, that the same applies to the rails, spikes, probably also to 
 each of the various classes of rolling stock, coal cars, freight cars 
 and passenger cars, as well as locomotives, if the system considered 
 is sufficiently large. The only exception to this general rule of 
 ascertaining present theoretical depreciated condition is when 
 the elements considered are few in number or relatively expen- 
 sive. For example, a highway company operating a large 
 bridge over a river could not apply the so-called Fifty Per Cent. 
 Rule, because the system of averages does not control. In the 
 same way, an electric light company could not apply the Fifty 
 Per Cent. Rule generally to all its property, where there was but a 
 single generating station containing few large units, although it 
 might apply such method to ascertaining the theoretical de- 
 preciated value of its poles, insulators, wires, meters or trans- 
 formers going to make up its distributing system. 
 
 In the preceding discussion, the term "depreciation" has been 
 used more particularly in reference to exhaustion of physical 
 property by reason of gradual wearing out. In case of inventions 
 or sudden developments in the art that immediately render 
 existing apparatus obsolete, or when by reason of exceedingly 
 rapid growth of business installed equipment becomes inadequate, 
 relatively large amounts of property may be almost instantly 
 depreciated, and in such cases the average depreciated condition 
 
 i"The Valuation of Public Utility Properties," by Henry Floy.
 
 238 VALUE FOR RA TE-MA KING 
 
 of the property, as a whole, might be well under 50 per cent. On 
 the other hand, the average general condition might be ap- 
 preciably above 50 per cent, in the case of utilities owning 
 relatively large amounts of phj-sical property that does not de- 
 preciate or depreciates very slowly; for example, a water power 
 property where a large percentage of the total investment is in 
 real estate, dams, canals, or similar structures. From the fore- 
 going it will be seen that there can be no question but that the 
 market value of utility property parts, considered for purposes of 
 sale without an inclusion of reserve or depreciation funds that 
 may have been accumulated, is very much less than the cost new, 
 even from the very instant installation is complete, and before 
 the new property has been put into service. There can be 
 no argument on this point, and it is freely admitted by all com- 
 petent authorities in valuation matters that value for the pur- 
 pose of sale and value for the purpose of rate-making are two 
 entirely different matters. That value for rate-making is not 
 market value may be illustrated by the fact that cast-iron pipe 
 laid in the streets for water mains may cost a dollar per running 
 foot when in place, but as soon as placed, that same pipe is not 
 worth, aside from the purpose and use for which it was installed, 
 more than a small fraction, perhaps 10 or 20 cts., of its original 
 cost. It would hardly be argued, by the most ardent enthusiasts 
 of market value as a basis of rate-making, that in the illustration 
 used, new pipe, just installed, is only entitled to a return on its 
 market value. It is generally recognized that many parts of 
 every utility are incapable of being detached and sold separately, 
 except on a basis of scrap value. Thus it will be seen that 
 theoretical depreciation, or market value, has little or nothing to 
 do with the value upon which rates should be based. The pur- 
 pose of a depreciation account is to insure the continued and 
 serviceable life of the physical plant as a whole; it is for the pur- 
 pose of providing against possible depreciation of the owner's 
 investment. 
 
 To fix rates upon depreciated value deters the making of 
 improvements, except for exhaustion of physical property. The 
 replacing of existing property before it is worn out, on the 
 grounds of obsolescence or inadequacy, would accord only scrap 
 value to the discarded property, thereby losing to the owners the 
 difference in value between scrap and the unaccrued depreciated 
 value. On the other hand, if cost new is taken as a basis of re-
 
 DEPRECIATION 239 
 
 turn allowed, the owner, being permitted to replace a depreciated 
 by a new unit without aiTecting his capital account (where the 
 cost of the old and the new unit is the same), will gladly and 
 promptly take advantage of any improvements in the art or 
 demands for greater capacity, in order to keep his plant thor- 
 oughly up to date. The use of depreciated values for rate-making 
 discourages invention or the substitution of improved or new prop- 
 erty for the existing plant. This is too frequently illustrated 
 by the endeavor of public utility corporations to keep what is 
 really superseded property or plant on its books and in use as 
 reserve equipment, in order that its value may be included in the 
 appraisals that are, or have been, made by public regulating 
 bodies. 
 
 "Absolute" and "Theoretical" Depreciation. — Before under- 
 taking to discuss proper methods of estimating and allowing for 
 depreciation, it is essential to have clearly in mind just how 
 depreciation actually takes place and in what way it effects 
 physical property. 
 
 Where property is no longer of service, it must be depreciated 
 down to the value at which it may be sold, even though that 
 value is as low as scrap value. On the other hand, apparatus 
 that is in use and rendering a service economically, may for the 
 purpose for which it was intended, be as valuable as when 
 originally installed, although its age may be approaching the 
 limit of its life. Take for example a steam engine which though 
 having been in use for the greater part of its estimated life is, 
 through proper maintenance, in as good condition to render 
 service as at any time in its history. If its annual maintenance 
 charge is no greater than in the earlier years of its history, its 
 "service value" to the company as a going piece of property is as 
 great as when first installed. 
 
 What then do we mean by depreciation? Reference to Fig. 1 
 indicates graphically several ways in which depreciation actually 
 takes place, as well as usual methods heretofore adopted in con- 
 sidering and evaluating depreciation. 
 
 Assume that a given piece of physical property has an esti- 
 mated life of twenty years, represented by the abscissa OB, and 
 that it has a given value in dollars, shown by the length of 
 the ordinate OA. Let the ordinate OC represent the worth in 
 dollars of the apparatus as scrap or junk, then the abscissa CD 
 will represent the scrap value throughout the life. This line
 
 240 
 
 VALUE FOR RATE-MAKING 
 
 is usually approximately a straight line, deviating therefrom 
 simply by fluctuations in the value of scrap material, which is 
 usually within fairly narrow limits. The point D is the value 
 of the apparatus in question at the end of its life. It may reach 
 this value through any one of several methods of depreciation, 
 shown graphically by the curves No. 1, 2, 3, 4, 5 and 6. 
 
 Curves 1, 2 and 6 may be said generally to represent "absolute 
 depreciation;" and curves 3, 4, 5 "theoretical depreciation." 
 
 Considering "absolute depreciation," curves 1 and 2 represent 
 the values, during any period of their lives, of most pieces of 
 physical property, determined from tlie standpoint of bargain 
 and sale for use elsewhere. The salable value- of new apparatus 
 depreciates very rapidly from the moment installed and then 
 gradually during the remainder of its Hfe down to "scrap value." 
 The values thus illustrated arc iiidependcnit of the service for the 
 particular installation for which the apparatus has been pur- 
 chased and installed. Curve 1 may fairly represent the worth 
 of certain pieces of property such as:
 
 DEPRECIATION 241 
 
 (a) Special machinery, the vahic of which, for use in connection 
 other than that for which it has ham installed, would necessitate 
 such a large expenditure for modification of design to make it 
 useful elsewhere that little more than scrap value can be obtained 
 from same. 
 
 (6) Property the cost of removing which, compared to its cost 
 new, is relatively high; for example, ties for track, or wootlen 
 poles of a transmission line. 
 
 Curve 2 represents sales value for more easily transported 
 property, as for example the rolling stock or synchronous con- 
 verters of a street railway system or transformers and meters of 
 a lighting company. 
 
 The classes of depreciation indicated by the curves 1 and 2 
 might properly be called salvage values and approximate scrap 
 or junk values, the principal difference being the propertj^ is sold 
 for what it is worth as a unit rather than for its dismembered 
 elements. It will be evident at once that depreciation of these 
 classes cannot fairly be used in determining the value, on the 
 basis of barter and sale in the general market, of the physical 
 property of an operating entity. That this is true and the view 
 taken by the courts will be evident from consideration of the 
 decisions in the Consolidated Gas and other similar cases and 
 even in the Knoxville Water case, which is generally considered 
 the most radical decision in the way of depreciating physical 
 value. 
 
 Curve 6 indicates depreciation due only to wear and tear until 
 just before the close of life, at which time other classes of deterio- 
 ration may appear. The curve is based on the assumption that 
 the apparatus in question will be used for the purpose for which 
 it was installed, throughout its life, and being maintained 
 in good operating efficiency, 100 per cent., is just as good for the 
 purpose of use as the day it was installed, aside from such slight 
 deterioration as results from wear and tear. That is, the value 
 of the apparatus or construction, being used for its original 
 purpose, is equal to its cost, new or original, less the evaluation 
 of the wear which has taken place; for example, a few tubes in a 
 boiler might be so badly burned as to render the boiler unfit for 
 service. The value of the boiler as a whole in its assumed condi- 
 tion is practically worth little more than scrap, but by the 
 expenditure of a few dollars in renewing the burned-out tubes 
 the value of the unit, say for the purpose of original installation
 
 242 VALUE FOR RATE-MAKING 
 
 and use, Is equal to the value of a new boiler. In any large 
 system there is constantly a large number of parts always 
 approaching the time of renewal. At any given instant of 
 appraisal some such parts will be found completely worn out and 
 the value of their replacement must be deductetl from the cost 
 new in order to obtain the real, actual ami "absolute" deprecia- 
 tion at the instant of appraisal. But assuming the property as 
 a whole is kept in first-class operating condition, that there is no 
 inadequacy, obsolescence, or deferred maintenance and ignoring 
 such slight deterioration as results from wear and tear at any 
 given instant which maybe apparent in detail parts in the sj^stem, 
 the depreciation effecting the value of the plant for the purpose 
 installed may be considered nil practically throughout its life, as 
 an operating property. In a given unit just before the close of 
 life other classes of depreciation than wear and tear may set in or 
 deferred maintenance may be allowed to appear, in which case, 
 of course, depreciation must be considered, but otherwise the 
 value of the property for its original use is equal to the cost to 
 reproduce new, and it is the real value of its physical property to a 
 "going concern." This value or its equivalent is that generally 
 allowed in "purchase and sale transactions," and has been recog- 
 nized by pul)lic service commissions and legal authorities. 
 
 "If the present value exclusively were to be taken as the basis, 
 respondent would not receive credit for having installed any part of its 
 plant at full cost. The present value, as of June 30, 190S, must, 
 therefore, be increased by the amount of the estimated depreciation on 
 that part of the plant which the company installed new."^ 
 
 "Of the physical plant alone, the most equitable valuation for rate- 
 making purposes appears to be best represented by the original cost of 
 the plant and by the cost of reproducing it."^ 
 
 This "service value" would also seem to be recognized by the 
 courts botii in rate cases and in determining valuations for sale.* 
 
 "Probably a fair statement would be that the physical value of the 
 plant is its value as a performing plant for the purposes for which it was 
 designed."* 
 
 ' F. B. L. Fuller vs. Wausau Street Railroad Co., Railroad Commission, of Wisconsin, 
 April 1, 1910. 
 
 *G. W. Hill el at. vs. Antigo Water Company, Railrmid Commission of Wisconsin, 
 August .3, 1909. 
 
 ^City of Omaha vs. Omaha Water Co. 1 1« T. S., 202. Wilcox vs. Consolidated Gas 
 C<i., 212 U. S.. 19. 
 
 * Columbus Railway & Light Co. vs. City cjf C^olumljus, Circuit Court U. S. Southern 
 District of Ohio, report of .Muster, page 34.
 
 DEPRECIATION 243 
 
 If any contrary position were assumed, namely, that only 
 "sales value," indicated under most favorable circumstances 
 by curves 1 and 2, were to be used in determining present value, 
 then a large portion of every going property would be practically 
 valueless the day after construction and installation was com- 
 pleted, because the expense of removal would amount to more 
 than the cost of new in the open market: for example, ties in a 
 railway property; foundations and settings for machinery; pipe, 
 deeply buried; cross-arms and many wooden poles. 
 
 Property — except real estate on road bed — cannot usually be 
 maintained at 100 per cent, of its original value; ultimate econ- 
 omy seeks only 100 per cent, operating efficiency. 
 
 In contradistinction to determination of present value by the 
 use of depreciation expressed in the curves 1, 2 and 6, which may 
 be termed "absolute," the curves 3, 4 and 5 indicate several 
 classes of "theoretical" depreciation which have been quite 
 widely used in some cases for estimating present values, but 
 more often for determining the yearly theoretical deterioration 
 for purposes of establishing depreciation funds, which, however, 
 is quite a different subject. Making a theoretical estimate of 
 the probable, future, average, annually accruing deterioration of 
 certain property to provide an item in book-keeping accounts of 
 operating expense has nothing whatever to do, in making an 
 appraisal, with fixing the definite amount of absolute, actual or 
 accrued depreciation which depends upon the present condition 
 of physical property, determinable from inspection and not upon 
 historical documents, depreciation funds, or disputed theoretical 
 conclusions. Nevertheless, the erroneous application of rates of 
 depreciation in the attempt to determine present commercial 
 values for purposes of capitalization is fairly common. 
 
 These three curves 3, 4 and 5 represent classes of depreciation 
 which seldom, if ever, occur in practice but are convenient for 
 purposes of estimate, particularly curve 3, which represents 
 what is called "straight line depreciation." As indicated, it 
 assumes a gradual and constant reduction in the value of prop- 
 erty throughout its life. The significance is that if, from the 
 cost of apparatus, the value to be obtained at the end of its life, 
 namely, the scrap value, is deducted, the remainder divided by 
 the assumed life, in years, of the apparatus, will give the amount 
 in dollars to be laid aside annually to accumulate a fund sufficient 
 to replace the property at the end of its life without interest.
 
 244 VALUE FOR RATE-MAKING 
 
 Curve 4 is closely related to curve 3; the annual depreciation 
 fund, however, being less because it is assumed that the uniform 
 amount of money laid aside annually during the life of the prop- 
 erty will be put out at interest and compounded so that owing 
 to the accumulation of interest the amounts annually laid aside 
 will be less than in the case of "straight depreciation." Curve 
 4 is called the "sinking fund" method. 
 
 Curve 5, a modification of curve 4, is based on the assumption 
 that, instead of laying aside a regular amount annually and com- 
 pounding, the amount laid aside will be small at first, gradually 
 increasing in amount as the earning power of a property in- 
 creases, as it generally does, with its life. These amounts are 
 then assumed to be put out at compound interest so as to aggre- 
 gate original cost of the apparatus at the end of its life. No 
 general rule has been developed as to the proper amounts to 
 begin laying aside or in what proportion they shall increase; but 
 it is clear that the smaller are the amounts in the beginning the 
 larger they must be toward the end of the life of the apparatus. 
 
 This latter plan of providing depreciation funds has the 
 advantage of more nearly proportioning the annual depreciation 
 payments in accordance with revenue, and for most pieces of 
 property will more closely approximate the deterioration actually 
 taking place. 
 
 A fourth plan of determining "theoretical" depreciation has 
 been used to limited extent. It consists in assuming a given 
 life for the property in question, ascertaining the annual rate 
 of depreciation and then applying that rate uniformly to the 
 principal diminished in amount each year by the deduction for 
 deterioration. For example, if the principal invested were 
 S2000 and the rate assumed is 10 per cent., the amount charged 
 off for depreciation the first year would be $200, leaving the 
 principal, $1800, on which 10 per cent, or $180 would be charged 
 off the second year, and $1G2 the third year, etc.; thus theamount 
 charged off becomes progressively less and the life of the prop- 
 erty becomes, theoretically at least, infinite. Of course this 
 method can be modified from the- "straight Hne" depreciation 
 illustration used above to the "sinking fund" method, if desired. 
 
 From the preceding it will be seen that any one of these four 
 methods of estimating depreciation is based on absolutely arbi- 
 trary assumptions. Practically there is no more logical reason 
 per se why the fund — if necessary — to replace the property at
 
 DEPRECIATION 245 
 
 the end of its life should be provided in any one of the several 
 methods suggested by the curves rather than in any other of the 
 several methods. Each method will accomplish the same result, 
 but it will be seen at a glance that in applying curves 3, 4 or 5, 
 the amounts to be laid aside annually will vary considerably, and 
 to that extent effect net income; similarly, the effect on the 
 worth of the owner's investment will also vary with the curve 
 used, being appreciably less for "straight line" depreciation. 
 
 Accruing Depreciation not Allowed. — Whatever weight there 
 may be in the argument that theoretical depreciation should be 
 deducted from cost new when properties are being considered 
 which have originated under public service regulation, such argu- 
 ments can have no weight with reference to such properties that 
 were in existence before the present regime of public control was 
 instituted. Not only were the owners of public utilities encour- 
 aged to consider that all revenue beyond that required to pay for 
 ordinary operating expenses was net income and belonged to the 
 owners, but the courts absolutely prohibited many public utility 
 owners from laying aside annually out of revenue, and accumu- 
 lating in funds, amounts considered necessary for providing 
 against future accrued depreciation. With these decisions of 
 the courts in mind, how unfair is it to insist that those utilities 
 doing business long before the present form of public utility regu- 
 lation began should have the value of their property determined 
 and their rates fixed on the basis of deducting theoretical accru- 
 ing depreciation from cost new, in order to ascertain so-called 
 present value, at least in amounts larger than those determined 
 by the accumulation in reserve funds established since public 
 service regulation was instituted. Not only have the State 
 courts in widely separated parts of the United States stated that 
 no deduction should be made from net income to provide against 
 accruing depreciation, before ascertaining the amount that might 
 fairly be paid out as dividends, but the Supreme Court itself has 
 ruled on this question and held that only expenditures actually 
 made can be claimed as proper deductions from earnings. 
 
 In 1890 the authorities of the City of San Diego, Cal., passed 
 an ordinance reducing and fixing the rates of the San Diego 
 Water Company. The company brought an action in the Supe- 
 rior Court of California to annul the ordinance and enjoin its 
 enforcement, on the grounds that the rates fixed were insufficient 
 to provide revenue sufficient to cover expenses and a fair return
 
 246 VALUE FOR RATE-MAKING 
 
 upon the value of the property. The Court found that the water 
 plant had cost S750,000 and " that the annual depreciation of 
 the plant on account of natural decay and use amounted to 31^ 
 per cent, of its value." 
 
 Thus it will be seen that in annual operating expenses the 
 Court included an amount to cover theoretical accruing depre- 
 ciation. This inclusion of an allowance for depreciation, the 
 Superior Court found, reduced the net income to an amount 
 insufficient to afford a fair return on the value of the property, 
 and in consequence the Court declared the ordinance void. 
 Upon appeal by the city to the Appellate Court of California 
 from the decision of the lower Court, above referred to, the 
 Appellate Court reversed the Superior Court, saying on page 574: 
 
 " With regard to the question of the depreciation of the plant by use, 
 it is sufficient to say that ordinary repairs should be charged to current 
 expenses, that substantial reconstruction or replacement should be 
 charged to the construction account, and that depreciation should not 
 otherwise be considered." 
 
 Two other judges who sat in the case wrote concurring opin- 
 ions; that of Judge Garroutte, on page 582, says: 
 
 "This balance (after making deductions for operating expenses 
 and interest) of $25,000 is profit, unless it is swallowed up by the finding 
 of the Court that the plaintiff's plant suffered an annual depreciation of 
 3H per cent., and the conclusion of law therefrom that a percentage 
 upon the investment to that amount should be added to the operating 
 expenses before the point is reached where profit begins. We are sat- 
 isfied that this finding has no support in the evidence, even conceding 
 the conclusion of law drawn therefrom sound. In the first place, the 
 evidence develops that there can be no general depreciation of this 
 plant as a whole. There are tunnels, wells, reservoirs, water rights and 
 real estate, amounting to more than one-half of the valuation of the 
 plant, there is no depreciation on these things; there is no wear and tear, 
 no permanent and gradual destruction by use and age. Most of them 
 stand as everlasting as the hills. 
 
 "The theory of the plaintiff in this regard seems to be that the life of 
 a plant of this character may be approximated at 30 years, and that a 
 sinking fund of one-thirtieth its value should be collected from the rate 
 payers annually and laid aside to be handed to the stockholders upon 
 the sad occasion of its demise, as alleviating salve to their sorrow." 
 
 Another judge writes a concurring opinion, which, however, 
 throws no particular additional light on the subject here being
 
 DEPRECIA TION 247 
 
 discussed. Out of the six judges who passed on the matter, only 
 one, Judge Beatty, wrote a dissenting and separate opinion 
 which says, on page 588: 
 
 "As to current expenses, all operating expenses reasonably and 
 properly incurred should be allowed, taxes should be allowed, and 
 the cost of current repairs. 
 
 "In addition to this, if there is any part of the plant, such as main 
 pipes, etc., which at the end of a term of years (20 years, for instance) 
 will be so damaged and worn out to require restoration, an annual 
 allowance should be made for a sinking fund sufficient to replace such 
 part of the plant when it is worn out."^ 
 
 From the preceding, it is clearly evident that the Court 
 thoroughly understood the question upon which it was ruling, 
 namely: whether or not an annual allowance to cover estimated 
 accruing depreciation of physical property, which must ulti- 
 mately be replaced, should or should not be included in operating 
 expenses. Judge Beatty definitely held that such allowance 
 should be included, but the majority of the Court overruled him 
 and held that no such allowance should be granted the owners 
 for the protection of their property. 
 
 In a later decision, the Appellate Court of California reaffirmed 
 its position with regard to allowances for depreciation where the 
 Redlands Water Company brought action to annul a city ordi- 
 nance upon the ground that 
 
 "the rates therein prescribed would not yield a revenue sufficient to 
 enable it to pay the interest on its indebtedness, its operating expenses 
 and taxes, and for keeping its plant in repair and replacing the same."- 
 
 The matter having been passed on by the lower, so-called 
 Superior Court, which had allowed $2,898.60, to cover 
 
 "the annual depreciation of the plant, aside from the amount requisite 
 for its maintenance and repairs during the year."^ 
 
 the Appellate Court, referring to its previous discussion of the 
 principles involved and its ruling in the preceding San Diego 
 case, again reversed the Superior Court's ruling and refused to 
 recognize the depreciation allowance or to annul the ordinance. 
 In view of the full discussion in the San Diego case, including 
 the ruling of the Superior Court and the reversal of the holding 
 
 > San Diego Water Co. vs. City of San Diego, 118 Calif. 556. 
 
 ^ Redlands Lugonia & Crafton Domestic Water Co. vs. City of Redlands et al. 121 Cal. 
 312.
 
 248 VALUE FOR RATE-MAKING 
 
 of this Court by the Appellate Court of California, and the re- 
 affirmation of the principles involved in the Redlands ease, it is 
 interesting to compare the rulings of the Railroad Commission 
 of California, which holds that the fair present value of utility- 
 property is found after deducting the amount of estimated, 
 accruing depreciation, which the Appellate Court has previously 
 ruled the owners of the property shall not be allowed to provide 
 out of revenue. Comment is unnecessary. 
 
 In the case of a disagreement between stockholders of the Flint 
 and Pierre Marquette Railroad Company, the Federal Court 
 refused to include in operating expenses certain charges that had 
 been made to cover accruing depreciation. The directors of the 
 railroad had charged to operating expenses certain items of new 
 construction, but as to certain steamboats operating on Lake 
 Michigan, the Court says: 
 
 "In 1884 there was a charge against expenses for depreciation on 
 these steamers amounting to $6,000. In 1885, there was a like charge 
 for depreciation, and also a charge of $2,500, as depreciation of dining 
 halls, the total charges making $14,500. These sums were not actually 
 expended out of earnings but were estimated and charged against oper- 
 ating expenses. This was not proper. No depreciation account was 
 either kept or warranted by the charter, as between the two classes of 
 stockholders, and no expenditures having actually been made to meet 
 such depreciation, the estimated amount thereof could not properly be 
 deducted from earnings or net income. The sum of SG,000 should, 
 therefore, be credited back to earnings for 1884, and $8,500 for 1885."' 
 
 The Supreme Court itself concurred in, and confirmed, the 
 holdings of the lower court by excluding from operating expenses 
 charges for accruing and unexpended depreciation. In the case 
 of the Federal Government vs. the Kansas Pacific Railway seek- 
 ing to determine the net earnings of the railroad, the Supreme 
 Court reversed the judgment of the Circuit Court, from which 
 appeal had been taken, expressly holding with regard to "de- 
 preciation account or expenses not charged up" that: 
 
 "This is explained to be the amount necessary to put the road in 
 proper repair, but which was not actually expended for that purpose. 
 We are clearly of the opinion that it is not a fair charge. Only such 
 expenditures as are actually made can, with any propriet}', be claimed 
 as a deduction from earnings."^ 
 
 • Macintosh el al. vs. Flint & Pierre Marq. R. R. el al. 34 Fed. Rep. 609. 
 
 * U. S. vs. Kansas Pac. Ry. Co., 99 U. S. 459. See also: Tutt vs. Land., 50 Geo. 339, and 
 Emery vb. Wilson, 79 N. Y. 78.
 
 DEPRECIATION 249 
 
 Depreciation Estimates Inaccurate. — There is no way of abso- 
 lutely and accurately measuring the amount of accruing, theoreti- 
 cal depreciation existing in physical property at any given time. 
 All estimates of theoretical depreciation are based on assumptions 
 as to the probable life, which is fixed from a consideration of the 
 law of variation of the periods of expiring usefulness of the 
 different elements of property. It is only when a particular 
 unit has been abandoned, or replaced, that fact replaces judg- 
 ment and estimate, consequently, the accurate amount of accru- 
 ing depreciation, which exists in any individual element at a given 
 time, is indeterminate. Theoretical depreciation can be assumed 
 to apply only to sufficiently large groups of units of the same type 
 and character, so that the law of chances, or the average law 
 of contingencies will apply. Consequently, the futility of 
 attempting to determine the theoretical depreciation of a single 
 unit, differing from all others as to size, or type, owned by the 
 same utility, is at once apparent. The application of an average 
 life, determined from the consideration of the shortest life, and the 
 longest life with all intermediate lives of similar pieces of appara- 
 tus in various localities, and existing under widely different condi- 
 tions of service, may or may not be applicable to the particular 
 case being considered. Thus, it will be recognized that the at- 
 tempt to fix the value of any particular piece of property, render- 
 ing a given service by the application of general law, based upon 
 average results obtained vmder widely varying conditions, may do 
 great injustice, either by giving too high a value to the particular 
 element being considered — if it has been mistreated, and allowed 
 to get out of repair — or too low a value, if through high degree of 
 maintenance and little use, it is worth more than the average. 
 
 It is a fact, becoming to be generally recognized, that physi- 
 cal property does not deteriorate in accordance with the straight 
 line method of estimating depreciation; it more nearly approxi- 
 mates the sinking fund method, but in most instances that 
 method would have to be considerably modified to represent the 
 true rate of depreciation. ''The use of averages is misleading 
 and cannot be expected to yield results in line with a careful 
 study of the facts." Adaptability of the unit to the entire equip- 
 ment, conditions of use, care in maintenance and climatic con- 
 ditions, are all local factors, which mean variations from the 
 average. 
 
 That neither the straight line, nor the sinking fund method,
 
 250 
 
 VALUE FOR RATE-MAKING 
 
 nor estimating the condition at any given period, in even a large 
 number of units, accurately discloses the real depreciated condi- 
 tion is shown by the following explanation and illustrations of 
 actual depreciation rates given by Mr. Edwin Gruhl. 
 
 "As modified by the addition of a minimum service value, the de- 
 preciation rates upon a sinking fund and straight line basis may be 
 graphically illustrated in Fig. 2. An average life has been assumed of 
 40 years. At 20 years, or half the average life, the present value will 
 
 100 
 
 95 
 
 90 
 
 85 
 
 •80 
 
 75 
 
 70 
 
 I 65 
 
 S60 
 
 ** 55 
 o 
 
 •3 50 
 > 
 I 45 
 
 I 40 
 
 I 35 
 
 I 30 
 
 25 
 
 20 
 
 15 
 
 10 
 
 5 
 
 
 
 
 
 
 
 r- 
 
 
 ~ 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 s, 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 s 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Depreciation Rate 
 
 Straight Line and 
 
 Sinking Fund i% 
 
 Theories with Average 
 
 Life of 40 Years 
 
 
 
 
 
 
 
 \ 
 
 
 s 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 30 40 50 
 
 Years in Service 
 
 Fig. 2. 
 
 60 
 
 70 
 
 80 
 
 aggregate 50 per cent, upon a straight line basis and 68.7 per cent, 
 upon a 4 per cent, sinking fund curve basis. Upon a 3 per cent, curve 
 the percentage at the same age would have aggregated 64 per cent., 
 and upon a 2 per cent, curve it would have aggregated 60 per cent. 
 
 "The.se curves may be viewed in two ways. They may be supposed to 
 represent either the gradual deterioration in value of an average unit 
 of e(|uipment or the law of deterioration of a large numlx;r of units of 
 an}' life. If we deal with the average, we suppose upon the straight 
 line basis that 50 per cent, of its life and usefulness has passed away at 
 say 20 years, or one-half the average life, but that if the average 
 unit shall survive the average life oi- 10 years it will continue at a
 
 DEPRECIATION 
 
 251 
 
 minimum service percentage irrespective of the probability that its 
 additional expected life or usefulness is small or large. If we deal with 
 the group, however, we assume that at 20 years only 50 per cent, of the 
 group is expected to survive, and that at the average age, the survivors 
 will have an indefinite expectancy of life. 
 
 "The only method of testing these assumptions is to apply our actual 
 experience to these assumed rules. When observations as to the timing 
 of replacements from any cause are summarized in accordance with the 
 
 100- 
 95 
 90 
 85 
 80 
 75 
 70 
 
 <B 
 
 I 65 
 
 0) 
 
 M60 
 
 o, 
 S55 
 
 ? 
 
 Sso 
 
 o 
 
 m45 
 
 §40 
 o 
 
 I 35 
 
 
 
 — 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 '^ 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 ^ 
 
 
 
 
 
 
 
 
 
 
 
 
 Depreciaton 
 
 Kate 
 
 Water Works Pump 
 
 Alvord 
 
 48 Pumps 
 
 
 
 
 - 
 
 
 
 
 
 
 s, 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 ^ 
 
 s 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 \ 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 ^ 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 V 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 ^ 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 y 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 \ 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 L 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 ■v, 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 ~. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 — 
 
 — 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 * 
 
 20 30 
 
 Years in Service 
 
 Fig. 3. 
 
 40 
 
 50 
 
 usual statistical methods, they indicate that neither the sinking fund 
 curve nor the straight line represents the law of depreciation of the 
 group in practice. Two illustrations of actual depreciation rates have 
 been selected and are here graphically represented. 
 
 "Fig. 3 summarizes experience as to completed life in service of 48 
 water-works pumps secured by Mr. J. W. Alvord and published in the 
 Proceedings of the American Water-Works Association. The majority 
 of the pumps represented have been retired because inadequate, a few 
 were discarded because obsolete, and the remainder scrapped. 
 
 "No attempt has been made in these illustrations to separate data 
 as to replacements due to wear and tear as distinct from inadequacy,
 
 252 
 
 VALUE FOR RATE-MAKING 
 
 obsolescence or other causes, but neither lias this particularization been 
 made in the usual application of the straight line and sinking fund 
 theories. When experience data as to life of equipment in service are 
 regularly recorded, refinements as to causes will probaljly be a later 
 development. 
 
 "This method of charting observations is identical with that used by 
 actuaries in determining the expectancy of life of human beings. Such 
 experience is summarized in Fig. 4. 
 
 100,000 ■ 
 
 95,000 
 
 90.000 
 
 85.000 
 
 80,000 
 
 75.000 
 
 70,000 
 M 65,000 
 5 60,000 
 S 55,000 
 
 E 50,000 
 
 c 
 
 t 45,000 
 c 40,000 
 
 35,000 
 
 30,000 
 
 25,000 
 
 20,000 
 
 15,000 
 
 10.000 
 5.000 
 
 
 
 
 
 "^ 
 
 ~, 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 1 1 1 1 1 1 1 1 1 1 1 1 
 
 
 
 
 
 
 
 
 
 
 s 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 1 1 1 1 1 1 1 1 1 1 1 1 
 
 
 
 
 
 
 
 
 
 
 
 
 s 
 
 
 
 
 
 
 
 
 
 
 
 
 Humaa 
 
 Mortality Curve 
 
 Oombined Kxperience 
 
 Institute 
 
 of Actuaries 
 
 ~ 
 
 : 
 
 
 
 
 
 
 
 
 
 
 
 
 s 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 s 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 V 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 s 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 V 
 
 20 
 
 30 
 
 40 50 
 Age 
 
 Fio. 4. 
 
 60 
 
 70 
 
 80 90 
 
 "This latter curve is designed to fit two causes; one, chance without 
 previous disposition to death or deterioration, the other an increased 
 inability to withstand destruction. Life statistics of utility equip- 
 ment where the element of chance such as obsolescence or inadequacy is 
 small and the gradual deterioration the main cause of depreciation may 
 be expected to group tliemselves as the life data summarized in Fig. 4. 
 
 "Generally, any life data, the average of wliich exceeds the middle 
 life value will result in a mortality curve the upper or concave portion of 
 which will be more extended than the lower or convex portion of the curve. 
 
 "The obvious advantages of the mortality curve method of deter- 
 mining present value over the straight line or sinking fund methods are: 
 
 "(a) Every point is determined by experience and where a large 
 number of instances of replacement have been utilized to determine 
 the character of the curve, additional data will make only slight modi-
 
 DEPRKCIA TION 
 
 253 
 
 fication. It is impossil)Ie therofore to generalize with insufficient data. 
 
 "(b) It is not dependent upon an aritlunetic average and is applicable 
 to any age whether or not the average life has been exceeded. 
 
 "(c) It measures the effect of all causes of depreciation affecting the 
 property and the effect of those causes at any age upon the average unit. 
 
 "(rf) When sufficient reliable data are available, it will permit by 
 actuarial methods, the calculation of the annual reserves, which, with 
 or without interest accumulations, as the case may be, will insure the 
 replacement of the various elements of property at the end of their 
 probable lifetimes. That there is a substantial difference between the 
 annual reserve required for a new property and that required for one 
 badly depreciated, readily follows. 
 
 "(e) It draws the line sharply between what is the rate of depreciation, 
 the appraisal problem, and the means of financing depreciation, the 
 reserve problem. 
 
 "Instances where actual data as to life in service are available, indicate 
 that both the straight line and sinking fund curve assume greater de- 
 preciation rates in the early years of life than obtain in the experience 
 indicated by a mortality curve, and hence result in lower present values. 
 
 "Let us assume for example that the mortality of a unit of equipment 
 with an average age of 20 years follows the observation as to life 
 in service of incandescent lamps. A comparison of straight line, sink- 
 ing fund curve and mortality curve will then result as follows: 
 
 Table IX. — Remainder Life or Condition Per Cent. Unit with 
 Average Life 20 Years 
 
 At end of 
 
 Straight line, 
 per cent. 
 
 Four per cent. 
 
 sinking fund 
 
 curve, per cent. 
 
 Mortality curve, 
 per cent. 
 
 2 years 
 
 90 
 80 
 70 
 60 
 50 
 40 
 30 
 20 
 '10 
 '10 
 ■10 
 '10 
 '10 
 '10 
 '10 
 
 93.2 
 85.7 
 77.9 
 69.1 
 59.7 
 49.6 
 38.7 
 26.7 
 14.0 
 '10.0 
 '10.0 
 '10.0 
 '10 
 '10 
 '10.0 
 
 99.4 
 
 4 years 
 
 97.5 
 
 6 years 
 
 94.5 
 
 8 years 
 
 90.5 
 
 10 years 
 
 12 years 
 
 85.3 
 79.4 
 
 14 years 
 
 72.7 
 
 16 years 
 
 65.4 
 
 18 years 
 
 57.8 
 
 20 years 
 
 50.0 
 
 24 years 
 
 34.6 
 
 28 years 
 
 20.6 
 
 32 years 
 
 9.5 
 
 36 years 
 
 2.5 
 
 40 years 
 
 
 
 
 
 ' Minimum service value.
 
 254 VALUE FOR RATE-MAKING 
 
 " In any valuation proceeding wlicro present values play an important 
 part, the necessity of securing actual and sufficient data as to variation of 
 life in service is evident. Theories which are generalized from in- 
 sufficient experience are equitable neither to the public utility, the 
 investor nor the community."' 
 
 Of courso, it will be recognized from what has been said and 
 from the curves shown by Mr. Gruhl that the preceding state- 
 ments of the author to the effect that, in considering any given 
 projxn'ty, average figures and curves, compiled from a large num- 
 ber of instances, must be used with care and judgment, even 
 when applied to similar articles existing in large quantity; 
 furthermoro, that such averages cannot fairly be applied when 
 considering but two or three units of a given type. Consequently, 
 theoretical depreciation, in determining so-called present de- 
 preciated value, cannot be used either from the standpoint of 
 fairness, or from what it is practicable for any accountant or 
 engineer to accomplish. This being the case, the fixing of values 
 and basing of rates bj^ the use of such methods is demonstrably 
 unscientific and illegal. 
 
 Any such basis of ascertaining present depreciated value, as 
 a basis of rate-making, is "fanciful," "speculative" and unsup- 
 ported by "reasonable judgment" or sufficient definiteness to 
 permit its acceptance by the Supreme Court, This will be evi- 
 denced, for example, by a comparison of the values shown in the 
 three columns quoted above from Mr, Gruhl's article. Taking 
 the period at 10 years of expired life, it will be seen that under the 
 straight line method, the item is only in 50 per cent, condition; 
 under the 4 per cent, sinking fund method, the value is almost 
 10 per cent, higher, or practically in 60 per cent, condition, whereas 
 under the mortality curve, it is in 85 per cent, condition. 
 There are arguments why any one of these three different values 
 should be assumed. Yet the investor, if the mortality curve 
 depreciation is taken, will be allowed 70 per cent, larger rate of 
 return than if a straight line assumption were made. Could 
 anything be more absurd and unfair to the investor! Yet, the 
 same property and the same investor, if located in New York, 
 under the ruling of the Public Service Commission, of the First 
 District, using the straight line method would at the end of 10 
 years have only 50 per cent, of the investment allowed as a basis 
 of fixing the rate of return; whereas, if the property were in 
 
 I •■ O.-prr-riation KHtiiiiati-b," by Edwin (Irulil, .4. E. R. A., March, 1913.
 
 DEPRECIAriON 200 
 
 Wisconsin, the llailroad Commission of that State, using a 4 
 per cent, sinking fund curve, would fix rates on 60 per cent, of 
 the cost new value. The use of such artificial and arbitrary- 
 methods of estimating "present value" is seen, for example, in 
 the change of chief engineers by the Wisconsin Commission. 
 Under a former engineer's direction, 80 per cent, was taken as a 
 minimum depreciated value of electric switchboards, and their 
 equipment; whereas, under a recent ruling of the present engineer- 
 ing force 30 per cent, is now used as a minimum value, so that 
 simply by reason of a change in the personelle of the organization, 
 the investor now has his rate of return reduced over one-half, 
 although the same switchboard and equipment may be in use, 
 and only a year or two older. Is further argument necessary to 
 show that such widely varying bases of estimate of value, de- 
 pending upon personal judgment and experience, which varies 
 widely, as between different individuals, cannot be used in 
 varying the value of the property used in serving the public? 
 
 The difference of opinion among engineers as to the fair and 
 proper annual allowance to be made to cover depreciation, and the 
 necessity for different allowances due to the different conditions 
 under which the physical property exists, is shown by the follow- 
 ing table, which indicates what is actually being done by various 
 railroad properties: 
 
 Table X. — Showing Various Annual Rates Used for Depreciation 
 OF Rolling Stock Equipment, Year Ending June 30, 1915' 
 
 Road No. 
 
 1 — An arbitrary charge of $1,200 per year. 
 
 2 — 4 per cent, of original cost less estimated value of salvage. 
 
 3 — 6 cts. per car-mile for maintenance and depreciation. 
 
 4 — 3 per cent, of the original value. 
 
 5 — 5 per cent, of the valuation of equipment. 
 
 6 — An arbitrary charge of $3,600 per year. 
 
 7 — 3 per cent, of record book value. 
 
 8 — One twenty-fifth of 75 per cent, of original cost. (Twenty-five year 
 life; 25 per cent, salvage.) 
 
 9 — Arbitrary deduction from income; $500,000 per year for several years. 
 10 — 1 per cent, of appraised value. 
 11^2 per cent, of value. 
 12 — 3 per cent, of cost of equipment. 
 13—1 per cent, of gross value. 
 14 — An arbitrary charge of $2,400 per year. 
 
 ' 'Depreciation and Appreciation," by W. H. Forse, Jr.; Electric Railway Journal, Deo. 
 11, 1915, page 1169.
 
 2.5G VALUE FOR RATE-MAKING 
 
 15 — One twenty-fifth of 75 per cent, of original cost. 
 
 16 — 5 per cent, of value. 
 
 17 — 2 p>er cent, of estimated value. 
 
 18 — 4 per cent, of estimated cost less 25 per cent, salvage. 
 
 19 — 2 ''2 per cent, of present value. 
 
 20 — Arbitrary charge of $12,000 per year. 
 
 21 — 2 F>er cent, of book value. 
 
 22 — 2^2 per cent, of inventory value. 
 
 23 — An arbitrary charge of $1,000 per year. 
 
 24 — 5 per cent, of appraised value. 
 
 25 — 6 per cent, of gross income. 
 
 26 — 6 per cent, of gross earnings for maintenance and depreciation. 
 
 27 — Arbitrary charge of 4.3 per cent, of investment. 
 
 28 — 5 f>er cent, of appraised value less estimated salvage. 
 
 29 — 10 per cent, of value. 
 
 30 — 5 per cent, of estimated value. 
 
 31 — 2 per cent, of book cost including betterments. 
 
 It ma}' be noted that the allowances made represent an ex- 
 pectation of life ranging from 10 to 100 years, showing the 
 necessity for consideration of local conditions by experienced and 
 intelligent engineers before conclusions can be reached as to 
 depreciation data. 
 
 What engineer is able to foretell the misuse and neglect or care 
 and high degree of maintenance that any given apparatus or utility 
 property as a whole will receive, even during the next 5 or 10 
 years, with vicissitudes of climate, load conditions, changes of 
 management and requirements of the pubhc? Estimates as to 
 the future life of utility physical property must necessarily be 
 too tentative, speculative and inexact to permit fixing definite 
 and positive values thereon. 
 
 The various tables published and ordinarily used by engineers, 
 as representing the lives of physical property, are based upon 
 figures and expenence that include expiration of life due to both 
 age and functional depreciation. As a matter of fact, the natural 
 life of much physical property is unknown. The limit of the 
 natural life of so widely used property as cast-iron pipe, for 
 example, cannot be stated positively and authoritatively, for in 
 the Gardens of Versailles, France, such pipe has been in use con- 
 siderably over 200 years and is still in excellent condition. Fur- 
 thermore, the expiration of life due to functional depreciation is 
 little more than a guess, based on necessarily limited past ex- 
 IX'rience, generally involving both natvu'al and functional de- 
 preciation. Consequently, value to be determined by estimates
 
 DEPRECIATION 257 
 
 of depreciation, which involve knowledge that is based on neces- 
 sarily too meager data, or prophecies that are merely human 
 guesses, cannot fairly be used. 
 
 "It is clear from the foregoing that the manner in which the subject 
 has been treated in the past is always an element of great importance 
 in reaching the conclusion in a rate case when a portion of the life of 
 the property has expired. If the company has consistently proceeded 
 upon tlie sinking fund theory, it would be inequitable to change suddenly 
 to the straight line method of depreciation, and vice versa. * * * 
 
 "These mathematical computations need not be continued, their sole 
 purpose in this place being to present in clear form the fact that it is 
 impossible in a rate case equitably to adjust the matter of depreciation 
 without considering how it has been handled by the company in the 
 past. If it has been handled in the past upon the straight line method, 
 a change to the sinking fund theory would obviously be unjust to the 
 public and give greater returns to the company than it is entitled to, 
 because an essential element of the sinking fund theory is that the 
 company gets no benefit from the sinking fund until the end of the term, 
 and therefore the return upon capital must be continued upon the full 
 amount of the investment until the term of life of the property has 
 expired."^ 
 
 Perhaps the most notorious reversal of public utility commis- 
 sion valuation is that recently made by the Public Service Com- 
 mission of Washington in a decision issued Oct. 19, 1914, denying 
 the application of the Seattle, Renton & Southern Railway 
 Company for an increase of rates. In its opinion the Commis- 
 sion says: 
 
 "With reference to the valuation of right-of-way and terminals, 
 a rule of appraisal has been followed by this Commission from its in- 
 ception, and by the company's engineer in this case, with which the 
 Commission, as now constituted, cannot agree. A multiple has been 
 used as a result of which the fair average value of the right-of-way has 
 been doubled, and, in some cases, trebled." 
 
 This change of front, namely, the refusal to use a multiple 
 in land values, resulted in a reduction of the present depreciated 
 value of the property from $1,601,315 to $959,955, or nearly 40 
 per cent., due almost entirely to the different methods used by the 
 present Commission. Continuing further, the Commission says: 
 
 > Public Service Commission, State of New York, Second District, Louis P. Fuhrmaii 
 vs. The Cataract Power & Conduit Company, decided Apr. 2, 1913, P. S. C. R. 2d Dist., 
 Vol. Ill, page 720. 
 17
 
 2o8 VALUE FOR RATE-MAKING 
 
 "Shippers and passengers are now paying interest upon millions of 
 dollars that have no existence outside of the imagination or arbitrary- 
 notion of a so-called expert." * * * "We further hold that the 
 company had no right to include 'engineering, legal expenses,' etc., 
 'interest during construction,' 'discount and commissions' based on 
 this hold-up value of the right-of-way lands." 
 
 It seems too bad that newly appointed commissioners, evidently 
 without experience to qualify them for rate-making, should be 
 unwilling to rely on the judgment of experts — presumably quali- 
 fied — and state that "there is no logical reason, nor does justice 
 demand that the patrons of a public utility pay interest upon con- 
 jectural expenditures that were probably never made," simply 
 because they find that "under such a system this Commission 
 can never lower the rate once established." Commissions are 
 not appointed for the purpose only of lowering rates without 
 regard to justice. 
 
 It is, of course, argued that such imperfect and incomplete 
 knowledge as we have must be used in the estimates of the life of 
 physical property which are made the basis of allowances for 
 depreciation and the accruing of depreciation funds. While this 
 is acknowledged, it must be admitted there is no practical 
 objection to making an allowance to cover depreciation in the 
 future, based on our best judgment of to-day, which allowance it 
 is possible and fair to modify in the future by the amount that 
 experience demonstrates those particular allowances to have 
 been in error. This application of estimating depreciation can be 
 made without injustice to the public, or the utility, as allowances 
 provided l)y the latter may be kept intact and devoted to their 
 proper purpose, so that the public will ultimately receive the 
 benefit in the future on any excess allowances made in the 
 present. 
 
 There can be no question whatever that in order to conserve 
 the full value of an investment in a wasting asset, such as phys- 
 ical property, the amount of the annual theoretical depreciation 
 should be estimated and provided for out of revenue each year, 
 during the assumed life of the physical property. These aiimial 
 payments laid aside and reserved for the purpose of meeting 
 the necessary expenditure at some date in the future for replace- 
 ment, in no way affects the absolute value of the property render- 
 ing service to the public, or the value upon which rates are fixed 
 or return to the investor determined.
 
 DEPRECIA TION 259 
 
 In fact, the utilities themselves as a whole are only beginning 
 to appreciate and provide for all of those items of expense and 
 future depreciation which were not apparent in the early history 
 of corporation service. Even where these elements have been 
 appreciated, the exigencies of maintaining dividends and sus- 
 taining and improving the quality of the service have sometimes 
 necessitated the deference of these charges. 
 
 Depreciated Basis. Unfair Return. — Commissioner Thelen of 
 California, although preferring investment cost, rather than 
 reproduction cost, very clearly shows the fallacy of using re- 
 production cost reduced by theoretical depreciation as the proper 
 basis for determining rates: 
 
 "While I thus find myself unable to agree with defendant's argument 
 with reference to the estimated reproduction cost new theory, I find 
 that there is much merit in defendant's attack upon the basis resulting 
 from the subtraction from the estimate of reproduction new of theoret- 
 ical depreciation based upon mortality tables. Engineers frequently 
 ascertain what they call a 'per cent, value' by subtracting from the 
 estimated reproduction cost new, an item for theoretical depreciation, 
 which is ascertained by multiplying the average age of each class of 
 material by the theoretical depreciation obtained from so-called mor- 
 tality tables. The basis so secured may be just as unfair to the utility 
 as the basis of reproduction value new may be to the consumer. Thus 
 a public utility plant may originally have cost $10,000. The money 
 may have been invested honestly and with a fair degree of wisdom. 
 At the end of three years the plant may be giving 100 per cent, service. 
 The component parts have been correlated and the system is in first- 
 class working order. While the component parts may not be intrin- 
 sically as sound as when they were new, it would be a foolish waste 
 of money to renew them, for the reason that they are doing their work 
 and that they are giving 100 per cent, service, without any danger of 
 wearing out in the near future. Under these circumstances, an engineer 
 applying mortality tables and estimating the theoretical depreciation 
 at 5 per cent, per year, reaches the conclusion that the present value 
 of the plant is only 85 per cent, of the original investment, being the 
 sum of .$8,500. The Commission is accordingly urged to grant a return 
 based on an estimated present value of $8,500. If this return is allowed 
 at the rate of 8 per cent., an allowance of $680 will be made for interest. 
 The utility, however, has in good faith paid out of its pocket for capital 
 account the sum of $10,000, and is giving 100 per cent, service to the 
 public. What is to become of the remaining $1,500 which the company 
 has honestly invested? If a man loans $10,000 on a first mortgage, he 
 expects interest on the entire sum which he loans and expects ultimately
 
 260 VALUE FOR RATE-MAKING 
 
 to get back his entire principal. Why should this same man, if he 
 invests S10,000 in a public utility enterprise and keeps up his property 
 in first-class condition, so that he is rendering 100 per cent, service, be 
 refused a return on the difference between his investment and a theoret- 
 ical depreciated reproduction value? It may be urged that justice may 
 be done by placing the remaining $1,500 in a depreciation fund, which 
 fund may be invested and bear interest. As I shall hereafter show, 
 however, under the provisions of section 49 of the Public Utilities Act, 
 the income from investment of moneys in depreciation funds of public 
 utilities in this State must be carried in these funds and cannot be used 
 for the paj'^ment of interest on investment or operating expenses. The 
 injustice of apph'ing such theory becomes more apparent as the age of 
 materials and structures increases. If the theory is carried to its logical 
 conclusion and the engineer makes no allowance for repairs and replace- 
 ments, but confines himself strictly to the age of the structures and his 
 mortality tables, there will come a time when the value of the prop- 
 erty will have been depreciated to zero, so that no return whatsoever 
 would be allowed. While this maj^ be a fanciful case, it is of value in 
 testing the accuracy of the theory. It seems strange that public utilities, 
 in protesting against this theory, frequently do not seem to realize that 
 the real reason for their protest is that the apphcation of this theory 
 deprives them of a return of a portion of the money which they have 
 invested. It must also be remembered that the ascertainment of the 
 physical condition i)er cent, of a property is one thing and that the 
 ascertainment of a proper basis on which to give a return may be an 
 entirely different thing. The engineer frequently forgets this distinction, 
 and erroneously believes that his work is the same as that of the rate- 
 fixing authority."^ 
 
 The value of the investment, or the worth of the property in 
 the service of the public does not change because a part of the 
 capital may be changed. For example: cash working capital is 
 provided as a part of the investment. 
 
 It ordinarily consists of cash, materials and supplies. The 
 normal and proper amount of working capital — when once deter- 
 mined for a given corporation at a given time — is left unchanged 
 as a part of the value on which rates are fixed and return allowed, 
 regardless of the ratio betw'cen the cash and the physical property 
 making up the total working capital. 
 
 No one wouhl iliink of deducting the deterioration in the coal- 
 pile from the cash working capital, and yet the total value of 
 the fuel depreciates as fast as it is shoveled into the fire. Because 
 
 ' DecUion of thr- Hailroud ronmiission of California, Town of Antiooh vs. Pacific Gaa 
 and I'lfctric f'oin[)any, C'aMO \o. 400; J)i-ciHioii -No. llio.'), July (>, 1914,
 
 DEPRECIATION 261 
 
 the value of property, having a hfe extending over a period of 
 years, depreciates very slowly is no reason why that depreciation 
 should be treated in any different way than short-life property — 
 such as fuel — which is exhausted and renewed every few days. 
 Everyone recognizes that there is no necessity for varying rates 
 with the fuel account, which daily fluctuates in value, the de- 
 terioration of which is charged to operating expenses as fast as 
 it is consumed. 
 
 Why should similar temporary extinguishment of capital by 
 the partial transformation of investment in the wasting away of 
 physical plant be deducted from the worth of the property used 
 for fixing rates? 
 
 It has sometimes been argued that because for purposes of sale, 
 the present value of a property is determined by deducting 
 the sum of both absolute and theoretical depreciation from 
 the original cost, or reproduction new, that therefore such 
 present depreciated value should be used as a basis of rate- 
 making. The illogic of such a proposition will be evidenced from 
 the consideration of value in connection with a piece of real estate. 
 In the case of purchase or sale of real estate, carrying a mortgage, 
 the purchaser pays in cash the difference between the full value 
 of the property and the mortgage, assuming the obligation for the 
 mortgage, but because the new owner has paid only this difference 
 in cash, which may amount to but one-third, or one-half, of the 
 total value, no one would argue that the rent of the property 
 should be based on anything but the sum of the mortgage and the 
 cash payment — that is, the full value of the property. In the 
 same way, the purchaser of a utility in buying an operating 
 property, which does not carry with it a cash fund, or its equiva- 
 lent, equal in an amount to the estimated depreciation, pays only 
 for the present value obtained by deducting the sum of absolute 
 and theoretical depreciation from the full value. But in such 
 purchase, the new owner assumes the obligation to make good, 
 when due, the amount of all depreciation, which is equivalent 
 to a mortgage of that amount on the utility. Therefore, the new 
 owner is entitled to earnings and allowances for depreciation 
 on an amount equal to the sum of his cash payment, that is, 
 the depreciated present value plus the depreciation evidenced 
 and accruing on the property. 
 
 Using the depreciated present value as a basis of rates, the 
 older, more decrepit and dilapidated a plant is, the lower the rate
 
 202 
 
 VALUE FOR RATE-MAKING 
 
 to the public, so that a modern newly installed plant would be 
 unable to obtain competing business. 
 
 If a depreciated value is used, as a basis of return, instead of the 
 investor's being able to earn a fair return, say 8 per cent, during 
 the life of the property, he will be able to earn only an average 
 of 4.7 per cent., as shown in the following table, where there is 
 assumed an original investment of $100,000 in property, having 
 a life of 20 years, depreciated on the sinking fund basis com- 
 pounded at 4 per cent, annually. 
 
 If 3.358 per cent, of $100,000 = $3,358 is annually laid aside 
 and compounded at 4 per cent., this amount will, at the end of 
 20 years = $100,000. 
 
 Table XI' 
 
 
 
 Constant K. X 
 
 
 8 per cent, on 
 depreciated value 
 
 Age (years) 
 
 Constant K. 
 
 0.03358 
 per cent. 
 
 Depreciated value 
 
 1 
 
 1.00 
 
 3.36 
 
 $96,640 
 
 $8,000 
 
 2 
 
 2.04 
 
 6.85 
 
 93,150 
 
 7,730 
 
 3 
 
 3.12 
 
 10.47 
 
 89,530 
 
 7,460 
 
 4 
 
 4.25 
 
 14.25 
 
 85,750 
 
 7,170 
 
 5 
 
 5.42 
 
 18.25 
 
 81,750 
 
 6,860 
 
 6 
 
 6 . 63 
 
 22.40 
 
 77,600 
 
 6,. 5.30 
 
 7 
 
 7.90 
 
 26.70 
 
 73,300 
 
 6,220 
 
 8 
 
 9.21 
 
 31.15 
 
 68,850 
 
 5,870 
 
 9 
 
 10.58 
 
 35.5 
 
 04,500 
 
 .5,510 
 
 10 
 
 12.01 
 
 40.4 
 
 59,600 
 
 5,160 
 
 11 
 
 13.49 
 
 45.3 
 
 54,700 
 
 4,770 
 
 12 
 
 15.03 
 
 50 5 
 
 49,500 
 
 4,370 
 
 13 
 
 16.63 
 
 55.8 
 
 44,200 
 
 3,960 
 
 14 
 
 18.29 
 
 61.4 
 
 38,600 
 
 3,540 
 
 15 
 
 20.02 
 
 67.3 
 
 ,32,700 
 
 3,090 
 
 16 
 
 21.82 
 
 73.2 
 
 26,800 
 
 2,615 
 
 17 
 
 23.70 
 
 79.6 
 
 20,400 
 
 2,140 
 
 18 
 
 25.65 
 
 86.1 
 
 13,900 
 
 1,030 
 
 19 
 
 27.67 
 
 93.0 
 
 7,000 
 
 1.110 
 
 20 
 
 29.78 
 
 100 . 00 
 
 
 560 
 
 
 $94,290 
 
 It should be recognized in any case, that it is much more im- 
 portant to the future growth and welfare of a utility that there be 
 established a reasonably liberal valuation upon its property 
 than that it be given what might be considered an excessive 
 rate of return. Moreover a utility must have certain earnings 
 
 ' .\verage per cent, on investment = 4.714.5 per cent.
 
 DEPRECIA TION 2()8 
 
 to enable it to raise additional capital and if a commission fails 
 to allow full property values, it is confronted by the practical 
 necessity of granting a rate of return which may be considerably 
 in excess of that which public sentiment would approve. 
 
 Contrary to a rather prevalent popular notion and against the 
 opinion and desires of many, the courts and commissions are 
 not uniformly fixing rates of return upon the reproduction cost 
 new of the physical property reduced by theoretical deprecia- 
 tion. An examination of many decisions rendered shows that 
 the value finally accepted for rate regulation is an amount 
 as large as the actual cost or investment or reproduction 
 cost new. 
 
 The' Massachusetts Public Service Commission has repeatedly 
 taken investment without deduction for depreciation as the basis 
 of value for rate-making, and one very recent decision along this 
 line was handed down the first of last August in the case of the 
 Blue Hill Street Railway Company operating in the suburbs of 
 Boston. The Commission's decision in this case, followed the 
 precedent established in 1914 in the Middlesex & Boston Com- 
 pany's case. The Blue Hill Company had been unable, on ac- 
 count of small earnings, to accumulate reserves to offset depre- 
 ciation, the total deficiency for maintenance and depreciation since 
 1905, the Commission found to amount to $35,341. With re- 
 spect to accrued depreciation, the Commission says: 
 
 "The extent to which deduction should be made for accrued de- 
 preciation must, to some degree at least, be determined bj^ the method 
 employed in ascertaining the gross amount from which such deduction is 
 to be made. Because a method of deahng with depreciation may be 
 sound where such gross amount represents the cost of reproduction new, 
 it by no means follows that the same rule can be rigidly applied where 
 the 'gross amount represents honest and prudent investment. Under the 
 reproduction cost theory, credit is given to the company for apprecia- 
 tion on items entering into the estimate of cost (and often for 'going 
 concern value'), and it is entirely consistent with that theory to make a 
 deduction to the extent of existing depreciation on other items. On 
 the other hand, if a fair return is to be measured by the 'capital honestly 
 and prudently invested,' and if no credit is allowed for appreciation of 
 the property through an increase in land values or higher unit costs of 
 material and labor, it would hardly seem just to deduct the full amount 
 of the accrued depreciation under all the circumstances and without 
 reference to the causes of the failure of the company to make due pro- 
 vision for it.
 
 264 VALVE FOR RATE-MA KIXG 
 
 "The ruling of the commission in the Middlesex & Boston case was 
 accompanied by the express stipulation 'that if there is mismanage- 
 ment causing loss, such loss must be charged against the stockholders 
 legally responsible for the mismanagement.' In other words, the com- 
 pany is held to tlie same standard of honesty and prudence in the manage- 
 ment and maintenance as in the original acquisition of its properties. 
 It must, so far at least as it reasonably can, keep its investment good. 
 If through some fault of its own it has failed to make due provision for 
 dej)reciation, it cannot reasonably expect the public to pay a return 
 upon that portion of the investment which it has neglected to preserve. 
 But under a consistent application of the investment theory it would 
 seem in general that deduction should be made for the depreciation which 
 comes of age and use in so far only as the failure to make provision for 
 it is due to the payment of unwarranted dividends or is otherwise 
 attributable to mismanagement. 
 
 "In this case the stockholders have received no dividends whatever. 
 In view of the low earnings, the character of the territorj^ in which the 
 company operates and its past and present efforts to increase its revenues, 
 and after careful consideration of its history, the commission is of the 
 opinion that the failure to make provision for depreciation and the 
 virtual loss of invested capital caused thereby cannot justly be as- 
 cribed to mismanagement. To sum the matter up, the property has 
 depreciated in value in the public service, and the stockholders have 
 had no dividends. On the other hand, the public served has been 
 receiving transportation at less than real cost, and has, in efifect, used 
 up a portion of the property without giving an equivalent in return. 
 As stated in the Middlesex & Boston case, to hold under these circum- 
 stances that the accrued depreciation should be deducted would amount 
 to saying that money lost during the earlier stages of a public service 
 enterprise is irretrievably lost by the stockholders; that if perchance 
 rates have been fixed so low that the rate-payer has for a period of 
 years obtained a service at less than cost this is the permanent mis- 
 fortune of the stockholders, and that the public should never at any 
 time and under any circumstances be called upon to make up a deficit 
 thus incurred." 
 
 In conclusion the Board held that the Blue Line Company was 
 entitled to revenues sufficient to make an amount equal to a fair 
 return upon all the capital honestly and permanently invested 
 in the property, without any deduction for accruing or accrued 
 depreciation. That is, the company w'as entitled to a return on 
 S21,237 of capital funds previously used for reconstruction, as 
 well as the sum of SI 3,750 representing discount on bonds find- 
 ing a total value of the property of at least $500,000 upon which
 
 DEPRECIA TION 2G5 
 
 the public was not paying the company a fair return, and, there- 
 fore, the Commission authorized an increase in rates. 
 
 It is encouraging to sec the later decisions of commissions 
 and courts taking the correct view of the treatment of deprecia- 
 tion in determining the value of property upon which rates are 
 based. The Supreme Court of Idaho rendered an opinion last 
 summer of more than usual interest because of the clear, definite 
 statements made, as follows: 
 
 "So far as the question of depreciation is concerned, we think de- 
 duction should be made only for actual, tangible depreciation, and not 
 for theoretical depreciation, sometimes called 'accrued depreciation.' 
 In other words, if it be demonstrated that the plant is in good operating 
 condition, and giving as good service as a new plant, then the question 
 of depreciation may be entirely disregarded."^ 
 
 The superficial reader of the Supreme Court's decisions, notably 
 those in the Knoxville and Minnesota rate cases, says: "The 
 Court rules that depreciated value must be taken as the value for 
 rate-making." The Court does so rule; no one can take any 
 exception to that, but the Court further explains that to obtain 
 "depreciated value" or "present value," it is necessary "when 
 an estimate of value is made on the basis of reproduction new, 
 the extent of existing depreciation should be shown and de- 
 ducted." If on these instructions the expert proceeds to ignore 
 the rule that "existing" deterioration should be deducted, and 
 proceeds to estimate the amount of both "existing," obtained 
 from inspection, and "theoretical, accruing depreciation," as 
 determined from computations, then taking the sum of these 
 two items he deducts said sum from reproduction cost new, he 
 has not followed the instructions of the Court, but on the con- 
 trary done something for which the Court decision gives him no 
 warrant. 
 
 Theoretical depreciation measures the decrease in amount of 
 investment in perishable property, being the estimated propor- 
 tion of the time that has expired since investment was made to 
 the total number of years of estimated serviceability. Absolute 
 depreciation depends upon the existing character of the physical 
 property, the effect of the natural elements upon it and the care 
 with which it has been used and the amounts expended upon it 
 for maintenance and repair. Thus, it will be seen that there is 
 
 1 Murray vs. Public Utilities Commission, 150 Pacific Reporter 50.
 
 20() VALUE FOR RATE-MAKING 
 
 no nocossaiyor probable reciprocal relation between the deteriora- 
 tion of investment value and depreciation of physical property. 
 
 "Where the depreciation is deducted from the assumed cost of re- 
 production new of the property, tlie cost of reproduction new is taken 
 to be the amount of the original investment, and then the assumed 
 depreciation is deducted therefrom in order to get at what is termed the 
 actual vahie of the propertJ^ The question is whether this is just or 
 unjust to the company. 
 
 "Continuing the use of the figures, hereinbefore taken as the basis 
 of the illustration, we may assume that the property being investigated 
 is a machine which costs $20,000, and it has been in use 10 years, and 
 the rate is being established the eleventh year. The assumed term of 
 life of the machine is 20 years, and therefore the depreciation is 50 per 
 cent., and the value of the property in the public service is taken to 
 be only S10,000. 
 
 "Assume that the case presented is No. 5 above stated, namely, the 
 business for the 10 years the property has been in service has only 
 yielded the interest return of 6 per cent, and nothing whatever for the 
 destruction of capital. This is a common situation. The first 10 
 years it may be assumed have been employed in building up the business 
 and getting it to a point where it would pay proper returns upon the 
 investment. It has in fact yielded only $1,200 a year, when it ought to 
 have yielded, in order to fully reimburse the owners, $ 1 , 800 a year. Now, 
 if at the end of 10 years the rate-making power decides that the value 
 of the property in the public use is only $10,000, and makes a return 
 upon that both for use of capital and destruction of capital, the company 
 from that time on for this particular machine gets $600 a year for 
 use of capital and about $335 for destruction of capital. The clear 
 result is that the company by this method of treatment has absolutely 
 lost $10,000 of its original investment without any hope of return of 
 the same to it."^ 
 
 "The depreciation of a plant, though it may not be so apparent, is 
 just as real and substantial a charge against revenues as the wages 
 paid to operators or any other employee of the company. For the 
 public to refuse to pay, through addition to the rates, a sufficient allow- 
 ance to guarantee the company against seeing the plant, which it places 
 at the disposal of the public, gradually fritter away and become lost, 
 is unconscionable and inequitable. No just or fair-minded person any 
 longer expects this.'"-' 
 
 ■ Public Service Commission, State of New York, Second District, Louis P. Fuhrmann 
 ve. The Cataract Power & Conduit Company, decided Apr. 2, 1913, P.S.C.K., 2d Dist.. 
 Vol. in. pane 721. 
 
 '.Sixth AiiiiiKil Heport of the Nebraska State Railway Commission to the Governor.
 
 DEPRECIATION 207 
 
 Knoxville Case.— The master's report in the Knoxville case^ 
 shows that in obtaining the vahie of the property on which he 
 estimated the rate of return, he used higher unit prices than the 
 average; he included over $22,000 worth of service connections, 
 which had been donated by the water consumers; also $2,000 
 as a "contingent allowance for bad bottom," and he did not make 
 any deduction for wear and tear, deferred maintenance, in- 
 adequacy or obsolescence, adding the sum of both "complete and 
 incomplete depreciation" to the estimated depreciated value of 
 the surviving plant in order to obtain the value which he used as 
 the basis of rates. The Supreme Court very properly criticized 
 such procedure saying that it would obviously "lead to incorrect 
 results if the cost of reproduction is not diminished by the dete- 
 rioration which has come from age and use" and while the Court 
 did not attempt to decide how much of the master's value of the 
 tangible property should have been diminished by the deprecia- 
 tion which the property had undergone, it did state it would be 
 improper that "the amounts of complete and incomplete depre- 
 ciation should be added to the present value of the surviving 
 parts" in order to obtain the total plant to be used as a basis of 
 rate-making. 
 
 Is it not clear that in this case the Supreme Court consistent 
 with its decision in the Consolidated Gas case was pointing out 
 that such deterioration as that resulting from "age" and "use," 
 that is wear and tear, causing exhaustion of property, also de- 
 ferred maintenance, inadequacy, obsolescence, age — in the sense 
 that the life had completely expired — must be estimated and 
 deducted from replacement cost in determining fair present 
 value? If not, and the Knoxville Water case properly con- 
 strued means that present value is to be obtained by deducting 
 the theoretical depreciation from cost, how is it made consistent 
 with the decision in the gas case? 
 
 The term "complete" depreciation in this case refers to that 
 deterioration which represents "that part of the plant which 
 through destruction, or obsolescence, had actually perished as 
 useful property. The incomplete depreciation represented the 
 impairment in value of the parts of the plant which remained in 
 existence and were continued in use." The master's report in 
 the Knoxville case indicates that "complete" depreciation can 
 be determined by "a detailed examination of the property as it 
 
 ' City of Knoxville vs. Knoxville Company, 212 U. S. 1.
 
 208 VALUE FOR RATE-MAKING 
 
 stands to-day;" it must therefore cover that deterioration due to 
 inadequacy, obsolescence, deferred maintenance or property 
 worn out by "age and use" and not actually employed in the 
 service being rendered. It is these various classes of deprecia- 
 tion just specified, and not theoretical calculations based on 
 office records as to date of installation and assumptions as to 
 expectations of life that are referred to by the Court, in the 
 Knoxville and other cases, where the specific statement has been 
 made to that effect that depreciation must be deducted in de- 
 termining the value of property to be used in fixing rates. 
 
 That the Knoxville decision means all depreciation, both ob- 
 served or "complete," as well as calculated or "incomplete," 
 must be deducted from the cost new in order to determine 
 present value, has been insisted upon by certain courts and 
 decisions as the full and final conclusion of the whole matter, 
 without reference to or proper consideration of the principles 
 enunciated in the Consolidated Gas decision rendered the same 
 day, and of subsequent decisions more adequately presented and 
 better prepared. As is quite generally known, the Knoxville 
 Water Company case was not adequately prepared, or well 
 presented in comparison with our present-day knowledge of 
 these matters, so that the resulting decision, with many of the 
 dicta of the court, has been taken as too conclusive, based on 
 misapprehension of facts and misinterpretation of the Court's 
 meaning. With a more thorough understanding of the prin- 
 ciples of valuation and rate-making, subsequent decisions of 
 the Supreme Court may be expected to support conclusions in 
 conflict with those so frequently read into the Knoxville case, 
 rather than in confirmation of the rather common interpretation 
 of the decision in that case. 
 
 The master's failure to make any deduction for deferred main- 
 tenance, inadequacy or obsolescence, adding the sum of both 
 "complete and incomplete depreciation" to the estimated depre- 
 ciated value of the surviving plant in order to obtain the value 
 which he used as a basis of rates, corresponded to taking the 
 depreciated value of the existing property and adding thereto 
 the cost of all property which has been used in the past and which 
 no longer existed, the value of which should have been repaid 
 to the investors out of revenue as a part of operating expenses, 
 during the life of the now superseded property. 
 
 Although the Supreme Court says the master erred in adding
 
 DEPRECIATION 2()9 
 
 the sum of "complete" and "incomplete" depreciation to the 
 depreciated present value, it does not state that he would have 
 erred in adding only "incomplete" depreciation to the depreciated 
 value. While the language of the Court seems contradictory as 
 to different parts of the decision and its intent is not clear and 
 logical, the Court could not have considered that adding the 
 amount of "incomplete" depreciation to the present depreciated 
 value to obtain "present value' ^ would have been an error, other- 
 wise it could not logically have stated that renewals must be 
 paid for out of revenue as part of operating expenses, for 
 
 "if a different course were pursued the only method of providing for 
 the replacement of property which has ceased to be useful would be the 
 investment of new capital and the issue of new bonds or stock. This 
 course would lead to a constantly increasing variancy between -present 
 value and bond and stock capitalization, a tendency which would in- 
 evitably lead to disaster to the stockholder or to the public, or both."' 
 
 It is evidently the thought of the Supreme Court that present 
 value and the amount of capitalization as represented by stocks 
 and bonds, that is, the investment value, should correspond or 
 tend to equal one another, which would not and could not be the 
 case if "present value" were taken to mean present theoretical 
 depreciated value. The Court says: 
 
 "The company is not bound to see its property gradually waste, 
 without making provision out of earnings for this 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." 
 
 Could any statement be more explicit as indicating that the 
 original investment, if maintained by necessary maintenance 
 and renewals, is entitled to be considered in determining the basis 
 of fixing rates? How, then, could the Court hold in the same 
 decision that the amount of "incomplete" or estimated, theo- 
 retical, not yet accrued depreciation should be deducted from 
 reproduction cost new in order to ascertain the basis on which 
 to fix rates? The two lines of argument are absolutely incom- 
 patible. Evidently, what the Court had in mind was that the 
 investment value, which would be the same as the cost of repro- 
 duction new of a property just completed, should be reduced 
 
 ' City of Knoxville vs. Knoxville Water Company, 212 U. S. 1.
 
 270 VALUE FOR RATE-MAKING 
 
 only by the amount of complete depreciation, the value of which 
 must be provided out of earnings. 
 The decision states that 
 
 "A sufficient amount should be allowed from the earnings of a public 
 service corporation for making good depreciation of plant and replacing 
 deteriorated portions thereof," 
 
 This is a mere statement of a widely recognized, and generally 
 acknowledged principle in considering the distribution of revenue 
 of a public utility, although the actual application is, in many 
 instances, impossible, because of inadequate revenue and the 
 impracticability of raising rates. The court then continues: 
 "but amounts so expended cannot be considered as additional 
 to the original cost in valuing the plant for purposes of ascertain- 
 ing whether a rate is confiscatory." If these amounts that are 
 to be allowed and expended in making good depreciation are not 
 "to be considered as additional to the original cost," then may 
 they be added to the present depreciated value in determining 
 that value upon which rates are to be based. The answer is, 
 of course, in the negative; for, if the sum of all allowances, pro- 
 vided and expended over a long period of years, were added to 
 the present depreciated value of the property as found, the sum of 
 these quantities would exceed the replacement cost new, or the 
 "original cost." Consequently, the attempt to add the amounts 
 allowed, or expended, for making good depreciation, cannot be 
 used in any way in determining the value to be ascertained as 
 a basis of fixing rates. For to attempt to use such amounts 
 leads to reductio ad ahsurdimi. The only logical conclusion then 
 is that investment, original or reproduction new value, is the 
 primary basis to be used in fixing rates. But this value or basis 
 is to be reduced by the amount of "complete" or evidenced 
 deterioration such as obsolescence, inadequacy, deferred main- 
 tenance and the like, the cost of which must be borne by the 
 customer as a part of operating expense. Furthermore the 
 owner must mairitain his property, providing out of revenue 
 derived from rates a sufficient sum to take care of ordinary 
 operating expenses, wear and tear and, when earnings permit, 
 the necessary replacements, as the plant becomes exhausted 
 through "age and use." 
 
 "There is n(< controversy whatever over the proposition that the 
 pul)li(t must pay at soino time and in some form for tlie property which
 
 DEPRECIATION 271 
 
 is destroyed or used in affording it the service which it receives, and 
 there is no controversy over the fact that this return should be spread 
 equitably over the entire life of the property. * * * The public in 
 whose service the machinery has been worn out must pay the com- 
 pany for the machinery."' 
 
 Minnesota Rate Cases. — Nor does the decision of the Supreme 
 Court in the Minnesota rate cases decide that theoretical de- 
 preciation should be deducted from reproduction new^ to arrive 
 at present value as a basis for rates. At page 457 the Court 
 
 says: 
 
 "it is also to be noted that the depreciation in (juestion is not that which 
 has been overcome by repairs and replacements, but is i\m. actual existing 
 depreciation in the plant as compared with the new one. It would 
 seem to be inevitable that in many parts of the plant there should be 
 such depreciation, as, for example, in old structures and equipment re- 
 maining on hand. And, when an estimate of value is made on the basis 
 of reproduction new, the extent of existing depreciation should be shown 
 and deducted. * * * And when particular physical items are 
 estimated as worth so much new, if in fact they he depreciated, this 
 amount should be found and allowed for." 
 
 If the above quotation means anything, it would indicate that 
 the depreciation of the theoretical, estimated kind, which is 
 normally "overcome by repairs and replacements" is not the 
 kind of depreciation being considered by the Court, but only 
 "actual existing depreciation." This is evidenced, for example, 
 by deduction for the value of "old structures and equipment 
 remaining on hand," after having served their useful life, and 
 held, perhaps, for resale as scrap, or retained at full value in the 
 books by the corporation hoping to be allowed to thus artificially 
 increase the "fair value" of its property upon which the rate of 
 return is to be allowed. In the case of reproduction new, "the 
 extent of existing depreciation should be shown and deducted." 
 This repeated use of ^^ existing depreciation," and the word 
 "actual," certainly indicate that class of depreciation which is 
 in evidence, apparent to the inspector, capable of ascertainment 
 by examination to prove that it is "actually existing" is what is 
 being considered. The Court expressly further states that when 
 "physical items are estimated as worth so much new" deprecia- 
 tion is to be deducted, "if in fact they be depreciated," and pre- 
 
 1 Fuhrmann vs. Cataract Power and Conduit Co., Public Service Coniniission of New 
 York, Second District, No. UA, V. S. C. U., 2d Dist., Vol. Ill, page 71G.
 
 272 VALUE FOR RATE-MAKING 
 
 sumably not otherwise. In the very nature of physical property, it 
 is impossible after it has once been installed that full 100 per cent, 
 value can be represented by all the parts, except for the service 
 intended. Utility property, generally, is maintained in a con- 
 dition between 80 and 90 per cent., depending upon the particular 
 kind of i)ropert\', and cannot economically be maintained in a 
 better condition, but this 80 per cent, condition which can be 
 maintained year after year, indefinitely, cannot be had at all 
 without expentling the 100 per cent, of value. The Supreme 
 Court states that depreciation must be deducted on the par- 
 ticular physical items being considered, "if in fact they be de- 
 preciated." It will be noted the Court expressly raises the 
 question as to whether there has been depreciation, or not, by 
 the statement "if in fact they be depreciated." Absolutely, in 
 every case, if market value — regardless of value for service — was 
 considered, there would be depreciation of physical property 
 the instant it was installed and there could be no "if" in the case. 
 The use of "if" by the Supreme Court clearly indicates that de- 
 preciation should be deducted from reproduction new, only in 
 case deterioration has resulted in the service rendered by the 
 physical elements. For example, the installation of foundations 
 for a particular engine are almost worthless for any other engine 
 and are entirely worthless for an engine in any other location 
 and, yet, practically worthless as a marketable article, no one 
 would deny that the investor is entitled to earn a return on the 
 full 100 per cent, investment in said foundation. 
 
 If there is one thing that the decision of the Supreme Court 
 in the Minnesota rate cases clearly establishes, it is that unwar- 
 ranted assumptions, speculative bases and hypothetical conclu- 
 sions will not be accepted for facts by this Court. This expres- 
 sion of opinion runs all the way through the decision and clearly 
 indicates that the determination of value by artificial rules, 
 formulae and speculation, instead of by examination of condi- 
 tions, ascertainment of facts and positive testimony thereon, 
 will not have weight or carry conviction with the Court. Note, 
 for example, the following quotations from the decision: 
 
 "The ascertainment of that value (fair value of the property) is not 
 controlled by artificial rules. It is not a matter of formulae. * * * " 
 
 "The cost of reproduction method is of service in ascertaining 
 the present value of the plant, when it is reasonably applied and when 
 the cost of rei)roducing the property may be ascertained with a proper
 
 DEPRECTA TION 273 
 
 degree of certainty, but it does not justify the uocoptanco of results, 
 which depend upon mere conjecture." 
 
 " * * * It is not admissible to attribute to the property owned by 
 the carriers a speculative increment." 
 
 " * * * It is an increment which cannot be referred to an\^ criterion, 
 but must rest on a mere expression of judgment which finds no proper 
 test or standard in the transactions of the business world. * * * " 
 
 "For an allowance of this character there is no warrant." 
 
 Could anything be more definite or explicit in condemnation 
 of the use of "formulae" instead of reasonable judgment for 
 determining the fair present value of property? 
 
 The tacit acquiescence and final acceptance by public utility 
 corporations of the decisions of rate-investigating commissions, 
 fixing the rate of return upon the so-called present depreciated 
 value of property being investigated, has resulted in an absolute 
 confiscation of a part of the corporation's property. 
 
 Public Utility Decisions. — -That "present value" as ordinarily 
 used by the courts does not mean "present theoretically depre- 
 ciated value" is substantiated and recognized by public service 
 commission decisions. The St. Louis Commission in the Union 
 Electric Light & Power Co. case found the cost of reproduction of 
 the property on page 64 of their report to be $16,976,025; there 
 was deducted for depreciation $841,632, that is, 4.7 per cent., in 
 order to obtain the present depreciated value. The St. Louis 
 Commission declared for the principle here contended for in the 
 following clear language: 
 
 "In depreciating to arrive at the present value of the depreciable 
 property, the Commission does not consider it fair to make deductions 
 for anything but the present physical condition, and for items where 
 it is plainly apparent that the property has become obsolete and in- 
 adequate. The usual estimate of the life of the different parts of a 
 public service property, so far as they deal with obsolescence or inade- 
 quacy, are extremely problematical. These elements should not be 
 generally taken into account in determining the present value." 
 
 Later, the same Commission rendered a decision in the matter 
 of the United Railways Company, expressly stating that it 
 did not depreciate the property in determining the basis for rates, 
 thus following the precedent it set in the case of the Union 
 Electric Light & Power Company. 
 
 Still more recently, Oct. 14, 1913, the same Commission, in its 
 report on the Southwestern Telegraph & Telephone Co., reaffirms 
 
 18
 
 274 VALUE FOR RATE-MAKING 
 
 its previous rulings on the question here being considered, and at 
 page 21 adds: 
 
 ''The aim of regulation should be protection of the consumer and 
 just treatment of the investor. If the investors have placed a certain 
 amount of money in an equipment in the service of the public and are 
 maintaining and are obliged to maintain said equipment at the highest 
 efficiency, and are renewing all worn or obsolete parts as soon as they 
 became unfit for service, it would seem that they are performing their 
 full duty to the public and should be allowed to earn returns on the 
 amount invested in the public service for the equipment in the service 
 of the public, unless it can be shown conclusively that the public have 
 paid them back a part of their investment in the shape of clearly defined 
 depreciation charges. Where there has been no regulation in the 
 past and where it can be shown that there was no necessity of es- 
 tablishing a depreciation fund equal to the consumption of estimated 
 life of each item of equipment (see Appendix D, page 122), deduction 
 for theoretical depreciation in a rate case involving a large 'piecemeal' 
 built property in a normal and efficient state becomes in fact merely a 
 confiscation of past profits." 
 
 The Board of Public Utility Commissioners of New Jersey 
 in the well-known decision in the Passaic case of the Public 
 Service Gas Company, where the Board, commenting upon 
 the two methods of depreciation to determine the basis upon 
 which to figure the rate of return, theoretical and absolute de- 
 preciation, adopted the latter method in that case, deduct- 
 ing merely the observed, existing depreciation. The Board 
 found the cost of reproduction new $4,950,980, including 
 8250,000 working capital (cash, materials and supplies), from 
 which was deduced $200,980 on account of depreciation, that 
 is, 4.3 per cent., leaving the present value $4,750,000. If 
 depreciated theoretical present value had been used by the New 
 Jersey Commission a deduction from the reproduction value of 
 the physical property would have been made, amounting to 15 
 per cent, or 20 per cent., say $600,000 to $800,000, instead of 
 oidy 4.3 per cent., an amount which was actually less than the 
 cash working capital allowed. The Board's measure of deprecia- 
 tion was a deduction of such sum as in its judgment would be 
 sufficient, in their own language, "to place a given property in 
 first-class operating condition. " 
 
 The (Commission expressly rejected the theoretical method of 
 arriving at the depreciation that should be deducted from repro- 
 ductioii cost new as a basis of rates.
 
 DEPRECIA Tl ON 275 
 
 The Public Utility Commission of New Jersey, following 
 the principles adopted in the Passaic Gas case, that deduction 
 for depreciation should be based upon inspection rather than 
 theoretical amounts computed from estimates of expected life, 
 held in the case of the Delaware & Atlantic Telegraph & Tele- 
 phone Company: 
 
 "The magnitude of the utility's responsibility is therefore the sum 
 of the unexpired service value of tangible property plus the pecuniary 
 liability to make replacements as needed from its own pocket. As its 
 responsibility is measured by a sum in excess of the unexpired service 
 value of its tangibles, it would seem to us that the equitable base upon 
 which it is entitled to a return is in excess of the unexpired service value 
 of its apparatus, and approaches as a limit the total replacement cost 
 new of its tangible property. 
 
 "On the other hand it would appear that an allowance of replacement 
 cost new of tangibles as the base on which a return is to be allowed 
 (so far as tangible property is concerned) might in certain circumstances 
 be excessive. In comparison, for example, with a utility which has 
 to-day in its plant tangible property of a service value equal to the 
 service value new of its original investment in tangibles, or which has 
 accumulated a fund sufficient at any time to replace in full the expired 
 service value of its tangibles, the utility which has done neither of these 
 things but simply lies under the naked obligation to make such replace- 
 ments as required, is less meritorious and is deserving of somewhat less 
 allowance in the base for return. There is a greater assurance in the 
 former case than in the latter of prompt and. adequate addition of 
 needed items when without such additions a service of 100 per cent, 
 efficiency would be lacking." * * * 
 
 "While we are not confident that in the Knoxville Water case the 
 Supreme Court of the United States had before it any record of each 
 and every consideration properly to be considered in the matter of 
 making deductions from the replacement value new of tangible property, 
 it is tolerably clear that this deduction or abatement here proposed is 
 wholly in keeping with the valuation rule that seemingly may be 
 deducted from that opinion. Such abatement or deduction is only a 
 fraction of the total expired service value of tangible property in this 
 particular case. This moderate reduction has also this advantage: 
 that it is based upon certainly ascertained inspection or investigation, 
 and not upon the more or less conjectural allowances for depreciation 
 estimated by tables purporting to give the expectation of life of various 
 parts of the utiUty's plant. "^ 
 
 1 Report and Order of Board of Public Utility Commissioners, in the matter of Gately 
 and Hurley et al. vs. Delaware and Atlantic Telegraph and Telephone Company, de- 
 cided January 7, 1913.
 
 276 VALUE FOR RATE-MA KING 
 
 The New York Public Service Commission, in Nos. 154 and 
 156 (the Buffalo cases), found present value to be the investment 
 made by the owners, plus the unearned increment on real estate. 
 
 ''Updu this assumption it is absolutely just to tlie public and to the 
 company to compute the annual return for use of capital upon the basis 
 of the investment, and so long as the company continues to give good 
 service it will be entitled to an annual return upon that amount, be- 
 cause that is what it has in the business."^ 
 
 The Public Service Commission of Nevada, in the Ely Light 
 & Power Company decision, recently decided that present value 
 was the cost of reproduction new despite the arguments advanced 
 by some as to the decision of the Supreme Court in the Minnesota 
 rate cases. The Commission distinguishes the Minnesota cases, 
 where the question at issue was whether the rates were con- 
 fiscatory, from the ordinary and usual case of establishing fair, 
 just and reasonable rates. The Commission states that the Court 
 in that case 
 
 "nowhere lays down the rules that in the actual work of rate-making, 
 the body which is invested with such power must consider only the de- 
 preciated value. It does not follow that when such a body makes a 
 reduction in rates, it must cut to the very lowest point at which the 
 rates as prescribed would be sustained by a court. * * * In regulat- 
 ing public service utilities there is much to be considered, separate and 
 apart from the mere question of rates. While it is well settled that 
 the rates shall be reasonable, the question of their reasonableness is 
 to be determined by a consideration of every fact and circumstance 
 which has a bearing, and also by a consideration of the principles of 
 sound public policy." 
 
 The Nevada Commission fixed rates and 
 
 "reached its conclusion on the basis of the reproduction value (new) 
 of the company's property * * * after having added to the unit cost 
 prices of their engineer, made up on the basis of reproduction value 
 new, an additional 20 per cent. * * * for cost of engineering, super- 
 intendence, contingencies and interest during the construction of the 
 plant." 
 
 In the case of City of Helena vs. The Helena Light & Rail- 
 way Company, Public Service Commission of Montana, decided 
 Nov. 3, 1913, Sixth Animal Report, 194, at page 196, the Com- 
 
 ' Public Sorvico Commission, State of \ew York, Second District, Louis P. Fulirniann 
 VB. The Cataract Power & Conduit Company, decided Apr. 2, 1913, P. S. C. R. 2d Dist., 
 Vol. Ill, pugf 723.
 
 DEPRFAIA TJON 277 
 
 mission, after finding that the cost of reproduction new of the 
 physical property amounted to $250,000, says: 
 
 "Whether or not the valuation thus obtained is subject to deprecia- 
 tion and, if so, to what extent, is a matter of expert opinion, depending 
 upon the amount expended for maintenance, renewals, and permanent 
 improvement work, the period during which such amounts were ex- 
 pended and, in general, the 'state of repair' of the property. It will be 
 obvious that there can be no fixed percentage of depreciation applicable 
 to a utility that had been 'kept up' from year to year by constant 
 effort, and the purchase of improved devices, as compared with one 
 that had been allowed to deteriorate through neglect; hence the prin- 
 ciple of an arbitrarily established measure of depreciation is untenable. 
 
 "Assuming that rates were being made for a new plant, it would be 
 the total capital that must be considered as entitled to bear interest, 
 as there would be no accrued depreciation. Depreciation is a liability 
 against the allowance for future depreciation which, it is assumed, 
 has been taken care of. To simplify the matter, let us assume that an 
 investment is made in 1903 of $100,000 under a 20-year franchise, rate 
 of interest allowable 10 per cent, per annum, and figuring 5 per cent, per 
 annum depreciation. At the end of 10 years, or in 1913, the property 
 will have depreciated $50,000 and has a remaining value of a like 
 amount. Then if rates are made, based on the depreciated value, 
 they must be one-half of the original rates, although the service may be 
 just as efficient as it ever was, and in 10 years more the physical value 
 of the plant would be nil, and likewise upon the same basis of reason- 
 ing, the utility would not be permitted to charge anything." 
 
 The Wisconsin Commission, in Fullmer vs. Wausau Street 
 Railway Company, 5 W. R. C. R. 114, at page 127, says: 
 
 "If the present value exclusively were to be taken as a basis, re- 
 spondent would not receive credit for having installed any part of its 
 plant at full cost. The present value, as of June 30, 1908, must, there- 
 fore, be increased by the amount of the estimated depreciation on that 
 part of the plant which the company installed new." 
 
 The same Commission, in Hill et al. vs. Antigo Water Co., 
 3 W. R. C. R. 623, says: 
 
 "Of the physical plant alone, the most equitable valuation for rate- 
 making purposes appears to be best represented by the original cost 
 of the plant and by the cost of reproducing it." 
 
 The same Commission, in City of Whitewater vs. Whitewater 
 E. L. Co., 6 W. R. C. R. 132, at page 138, says:
 
 278 VALVE FOn RATE-MA KIXC 
 
 "As it is a general rule that the reasonable return which a utility is 
 allowed to earn covers interest and depreciation on the actual invest- 
 ment in the plant, it becomes important to know what the investment 
 in the plant actually is, that is, what is the value of the plant new. The 
 fact that the property of the utility has diminished in value with use, 
 as the inevitable result of depreciation, does not lessen the amount of 
 the investment in the plant for rate-making purposes." 
 
 The Public Utilities Commission of Connecticut has fully 
 accepted the theory here contended for in the case of Herbert 0. 
 Bowers et al. vs. Connecticut Company, Docket No. 8, page 
 11, as follows: 
 
 "We do not think that the original cost of construction, whatever 
 that may have been, the price paid for the line by the Connecticut 
 Company, whether exorbitant or otherwise, or any inflated value for 
 the issue of stocks or bonds are proper standards to determine the value 
 of the plant and equipment for which the company is entitled to receive 
 a fair income; but the cost of reproduction at the present time in this 
 particular case is a more accurate standard, and the one which the 
 Commission has followed in determining such value." 
 
 Individual Opinion. — Commissioner Erickson, of the Wisconsin 
 Commission, in his paper before the Indiana Sanitary and Water 
 Supply Association, dated Feb. 15, 1912, on page 10 says: 
 
 "When the plants are constructed to meet public needs and when 
 deemed as of great or of greater value than their cost; when those who 
 furnish the capital did so in good faith; and when ordinary judgment 
 was used in all matters pertaining to the undertaking, then it would 
 seem that there is little room for questioning the fairness of the actual 
 cost." 
 
 And again, at page 24: 
 
 "Cost, both reproduction and the original, as explained herein, for 
 industries where monopoly conditions obtain, represent the rights of 
 the investors and the obligations of the consumers and furnish equitable 
 bases upon which to adjust the relations as between these two classes." 
 
 And again, at page 37, of the same paper: 
 
 "On the whole the value that is just to both investor and customer 
 is that value which is represented by costs. A reasonable valuation of 
 the sacrifices involved in furnishing the service constituted the fairest 
 basis for just charges. Upon this amount the investors are ordinarily 
 entitled to reasonable returns. The cost appears to be the best and 
 safest basis, not only for valuation, but for earnings or rates. 
 
 "Hill d nl vs. Antigo Water Co. (1909), 3 W. R. C. R. G23.
 
 DEPRECIA TION 279 
 
 In re Menominee & Marinette Light & Traction Co. (1909), 3 
 W. R. C. R. 778. 
 
 State Journal Printing Co. et al. vs. Madison Gas & Electric Co. 
 (1910), 4 W. R. C. R. 501. 
 
 City of Milwaukee vs. Milwaukee Gas Light Co. (Aug. 14, 1913), 
 12 W. R. C. R., No. U-234." 
 
 Mr. Cromwell, chief engineer of the New York Public Service 
 Commission, Second District, in the Westchester Lighting 
 Company case testified as follows: 
 
 "As a general proposition in considering depreciation, it must be 
 remembered that the respondent is required to furnish 100 per cent, of 
 service, with the plant as it exists, and is entitled to a fair return upon 
 100 per cent, of investment value" (page 6). 
 
 Q. It doesn't make any difference to the consumer whether the gas 
 main supplying his premises is one year old or fifty, assuming them to 
 be equally efficient? 
 
 A. Not if satisfactory and adequate service is rendered. 
 
 Q. It doesn't make any difference to the consumer whether the holder 
 in which the gas which he consumes is stored, is five years old or thirty, 
 assuming an unimpaired service value? 
 
 A. Not if satisfactory and adequate service is rendered. 
 
 Q. Does the failure of the owner of the property to lay aside reserve 
 for the replacement of property in any way affect the consumer? 
 
 A. Not if satisfactory and adequate service is rendered" (pages 
 3122-3). 
 
 Prof. George F. Swain, engineer of the Massachusetts Joint 
 Commission, established in 1910 to ascertain the relation between 
 existing capitalization and property value in the case of the 
 New York, New Haven & Hartford Railway Company, in his 
 report, says: 
 
 "If, then, the company is to keep its railroad as good as new, so far 
 as operating is concerned, or perhaps in view of what has previously 
 been adduced better than new, charging the cost of repairs and renewals 
 in kind to operating expenses, it certainly ought to be allowed a capital 
 corresponding and to charge rents sufficient to allow of such repairs and 
 renewals. It is the duty of the railroad company to maintain this 
 property practically as good as new, and the State has power to compel 
 the owners of the property to do so. Portions which are worn out must 
 be replaced out of operating expenses, and for the purposes of operation 
 the property is always as good as new. If, therefore, the valuation is 
 for the purpose of justifying rates or capital, 100 per cent, valuation 
 should be taken."
 
 280 VALUE FOR RATE-MAKING 
 
 Mr. Bion J. Arnold, an engineer of national reputation, a man 
 who has been much employed by the public, by many of the 
 principal cities as Chicago, New York, San Francisco, Cincinnati, 
 Toronto, etc., in a statement made by him before the American 
 Institute of Electrical Engineers, in 1911, takes the position that 
 the "fair rate of return" should not be based upon the depre- 
 ciated value of the property, in the following language: 
 
 "I maintain and always have, when you are considering a question 
 of rate-making, that the company asking for the rate should be allowed 
 a rate based upon the cost to reproduce the property new, taking into 
 consideration the development expenses which I have mentioned, and 
 that a condition precedent to that valuation requires the property 
 to be in first-class condition so as to be able to give first-class service 
 and if the property is found to be in bad physical condition, that the 
 company has no right to ask that the rate be based on the cost to re- 
 produce new, unless the company has in its treasury, or has somewhere 
 a depreciation reserve fund, such as we have in Chicago, provided of 
 course it has been able to earn such a fund sufficient to put the property 
 in first-class condition, so as to give a first-class service, which is what 
 you require of it, and which is the condition you require it to be kept 
 up to in order to entitle it to the rate you give it. 
 
 "Many communities will attempt to fix a rate upon the depreciated 
 value of the property. I think that is a short-sighted poHcy from the 
 standpoint of the public, because if the rate is fixed on that value the 
 company has no chance to raise enough capital to put its property in 
 first-class condition, to give first-class service, and consequently the rate 
 should be based upon the capitahzation to reproduce the property new." 
 
 Dr. Alexander C. Humphreys, a leading consulting engineer 
 and a practical operator of utiUties, who is recognized as a noted 
 student of the questions here being considered, said: 
 
 "Finally, nothing that I have said as to the determination of actual 
 'depreciation' is to be taken as an admission that in a ftite-fixing case 
 any deduction should be made from the appraised cost to reproduce 
 plant new to cover so-called accrued depreciation, or, more correctly 
 speaking, the accrued liability against the stockholders for final renewals 
 or replacements. This is a liability resting against proprietors; and 
 they must be given the normal opportunities to meet this liabihty 
 without in the meantime suffering confiscation of investment by 
 anticipation of the dates when the several payments to meet this 
 liability may fall due."
 
 DEPRECIATION 281 
 
 "To me it is clear that in appraising the ph^ysical portion of a property 
 to determine its measure in capital, no further deduction for deprecia- 
 tion should be made than is measured by the cost of restoring the parts 
 to their full efficiency for production, and therefore that its condition as 
 to obsolescence, inadequacy, and physical decay and not its age should 
 determine the deduction, if any, to be made. If there is an accrued 
 depreciation in excess of the actual depreciation found as above, the 
 cost of renewal must be paid for from income. In the long run no in- 
 justice is so done to the consumer of the product, because the consumer, 
 first or last, should pay for the maintenance of the plant at its original 
 cost, provided the profits, whether paid out in dividends or carried into 
 surplus, are not found to be unfair; which is the very question at issue 
 and to be determined in these rate cases. * * * 
 
 " In the appraisal of a plant to determine the investment upon which a 
 'fair return' (whatever that may be determined to be — varying with 
 the general and local conditions) is to be calculated, it is not by any 
 means clear to me that there should be any deduction for depreciation 
 provided the plant is found to be in a condition to render efficient ser- 
 vice to the public. Certainly no such deduction should be made if the 
 income has not been sufficient to maintain the plant, provide for ac- 
 cruing depreciation, and afford a fair return on the investment."^ 
 
 Illustrations. — It would seem that however useful estimates of 
 life of property may be in establishing annual rates of deteriora- 
 tion, for accounting purposes, theoretical depreciation has no 
 place in determining the basis for fixing rates of return. If so, 
 by what method is theoretical depreciation to be determined? 
 At which month in the life of the physical property which ex- 
 tends over years is the present value to be estimated? Assume 
 that the life of a large part of a complete property is 20 years, 
 then at the end of 19 years and 6 months, if theoretical deprecia- 
 tion is considered, the present value of the property would be 
 small and the rates based thereon would include nothing in the 
 way of return on a large part of the property, still 100 per cent, 
 useful, a ye,ar thereafter the property being entirely replaced 
 and new, the rates would be incomparably higher and between 
 these two extremes, the rates will fluctuate depending on the 
 year or the month in which the present value is estimated. Con- 
 sider two surface railways running out parallel avenues from the 
 center of a city to the suburbs, both alike in construction but one 
 10 years old and the other put in operation within a year. If 
 
 ' Lecture Notes on Business Engineering by Alex. C. Humphreys; Second Edition, 1912.
 
 282 VALUE FOR RATE-MAKING 
 
 theoretical depreciation is considered the present vahics of these 
 two properties are quite different, the older road being worth 
 appreciably less than the new road, although the original cost 
 of installation may have been the same in both cases. Under 
 such circumstances, is the older road to be allowed to charge 
 only a 4-ct. fare, assuming that that gives a fair return on the 
 estimated present value, while the new road must charge a 5-ct. 
 fare for the same return on its estimated value? What would be 
 the result practically of such method of fixing rates? The old 
 road would be swamped with business and the new road would be 
 unable to maintain its earnings. Again, the theoretical present 
 value of the property of a lighting company might be found to be 
 50 per cent, of the cost new but such value would not properly 
 represent its worth in service to the public because it would prob- 
 ably be in such poor condition that continuous and satisfactory 
 service could not be rendered and the real worth and service to 
 the public would be very much below 50 per cent. On the 
 other hand, through extravagant management, and the replacing 
 of partly worn out apparatus before economically necessary and 
 the incurrence of abnormally high maintenance charges in order 
 to maintain the theoretical present value of the property at say 
 90 or 95 per cent., there would result unnecessarily high operating 
 expenses and unwarrantable charges upon the public merely 
 for the sake of maintaining a theoretical high present value on 
 which a fair rate of return must be allowed. A property of this 
 kind maintained at an abnormally high present-value worth, 
 would be of no greater service to the public than one of which the 
 present- value worth might be only 75 per cent., whereas the 
 burden to the public in maintaining the former property would 
 be very much higher than the latter. Can such fanciful and 
 variable bases be intended by the Supreme Court to be taken 
 as that on which rates are to be estimated and regulated? Such 
 conclusion would be illogical, unreasonable and unfair. Pro- 
 vided a property is kept in good order and at 100 per cent, work- 
 ing efficiency so as to render service to the public equivalent to 
 that of a new plant, the question of rates or value of property 
 in its service to the public has absolutely nothing to do with the 
 amount of reiserve funds the corporation may or may not have 
 accumulated. The value of any physical property, as must 
 of course be recognized, has no relation whatever to the amount 
 of money a corporation may have to its credit in the bank,
 
 DEPRECIATION 283 
 
 nor have rates for service, as far as we have ever heard, been 
 based on the amount of a company's surplus or reserve funds. 
 
 "The writer has before him, profossionally, an estimate, made by 
 an engineer of a State, of the present vahie of a Hne of raihvay. This 
 raihvay was constructed as one task within a period of about two years, 
 and cost about $5,000,000. The property was operated for some special 
 traffic during construction. The valuation was made as of a date about 
 20 months after the road was turned over to the operating department. 
 The State engineer finds its original cost and its reproduction cost; and 
 tlien he estimates the 'condition per cent.' of each item of physical 
 property, and averages them for the total, with the result that he esti- 
 mates the present value — the value on which the owner is entitled to a 
 return without interference by the State — as 95 per cent, of the amount 
 of present cost of the property. If the property actually and reasonably 
 cost $5,000,000 two years before this valuation was made, and could 
 reasonably be reproduced at the time of the valuation for not less than 
 that amount, as might well be assumed, then, if the owner shall be 
 limited at the time of the valuation to a return on only $4,750,000, it 
 seems to be clear enough that somewhere he has wholly lost, or has at 
 least lost the valuable use of $250,000. There is no force in the sugges- 
 tion that he is entitled to earn and lay aside this $250,000 during this 
 period of two years in which depreciation is alleged to have accrued. 
 Even if he shall be able to earn it, he may not consider it as a return 
 of a part of his investment and devote it to his private use as such. 
 He is under exact obligation to use it in replacing the depreciating articles 
 when they shall have depreciated to the point of ineffectiveness (italics 
 are the author's). In other words, because the proper maintenance 
 of the property is the very first charge against the earnings of a railroad 
 company, and because the property must be maintained ordinarily in 
 perpetuity, money properly necessary for replacement of portions of the 
 property when they shall have depreciated into inefficiency, and reserved 
 by the company for that purpose, may just as well be said to be devoted 
 to the public use as may the physical property of the company actually 
 used in operation. It may, perhaps, be invested by the company until 
 the necessity for its use arises, but if the investment proves unfortunate 
 and the money is lost, it must be replaced, and, apparently, at the ex- 
 pense of dividends which otherwise might l)e properly payable; and, if 
 the depreciation fund is invested and produces income, of course that 
 income ought to be included in the general income of the company 
 on the net of which the reasonableness of its rate of return is to be 
 figured."^ 
 
 ' Jared How, Esq., Proceedings of the American Society of Civil Engineers, Vol. XL, No. 
 2, February, 1914.
 
 284 VALUE FOR RATE-MAKING 
 
 Until comparatively recently, practice has paid too little atten- 
 tion to the necessary allowance to be made for the element of 
 depreciation. In order to show net earnings that would main- 
 tain the credit of the utilities, or warrant the issuance of addi- 
 tional securities, or, in some comparatively few instances, to 
 permit payment of unwarranted dividends, only that part of the 
 total depreciation annually observed, namely, wear and tear, 
 has been provided for; the remaining portion of depreciation, 
 namely, renewals and replacements, future inadequacy or obsoles- 
 cence, the demand for which was not yet apparent, has been de- 
 ferred perhaps without full appreciation of the fact that theo- 
 retical depreciation must eventually be provided for just as surely 
 as ordinary maintenance expenses, if the property is to be con- 
 tinuously maintained in first-class operating condition. 
 
 "The question whether depreciation is a proper operating charge 
 is no longer open to debate. The opinion of Mr. Justice Moody, 
 already cited, reflects the generally recognized rule that rates should be 
 sufficient to permit current repjairs to be made, parts to be replaced, 
 and other charges met, so that by one means or another the investment 
 may be kept unimpaired. In order that this object may be attained, 
 every part of the property must be considered, and wherever there is 
 decrease in value, provision must be made for an off'set in one form 
 or another."^ 
 
 Of course, this estimated cost of future renewals is as much a 
 part of the annual operating expense as is the cost of wages, fuel, 
 current repairs, taxes, or interest, and if not included in the annual 
 expense, the net profits are incorrectly stated. Due largely to the 
 demands of the public for reduced rates, and the insistence on 
 the part of regulatory bodies that utility properties be maintained 
 in first-class operating condition, there has recently resulted 
 general recognition of the necessity for providing for those 
 elements of deterioration which are silently accumulating in the 
 present, although not demanding expenditures until some time 
 in the future. While, of course, it is impossible to keep property 
 at 100 per cent, condition of its investment value when taking 
 into account theoretical depreciation, which is accruing but not 
 accrued, it does not follow that value for rate-making should 
 be based on anything less than the 100 per cent, value. To re- 
 quire a utility to maintain its investment at practically 100 per 
 
 ' In re Qui-fiiB HorouKli Gas & Electric Co., 11 P. S. C. R. 544.
 
 DEPRECIATION 285 
 
 cent, value would mean the renewal of parts long before they 
 were worn out, that is, a deliberate waste of material and equip- 
 ment in which there still remains large service value simply for 
 the purpose of permitting the investor to establish a basis on 
 which to earn a higher rate of return. 
 
 With all the smaller utilities it is necessary to provide a depre- 
 ciation reserve fund for the purpose of spreading the cost of final 
 renewals of deteriorated property equally over the life of such 
 property. While this setting up of a fund results temporarily 
 in decreasing funds available for dividends to stockholders, never- 
 theless, in the end the stockholders receive the same amount, 
 because if the fund is not set up, all earnings being paid out as 
 dividends, when the time arrives for the renewals and replace- 
 ments, no funds being in hand, their cost must be taken from net 
 earnings in such large amounts as to cause a temporary deficit, 
 or certainly the material reduction or entire discontinuance of 
 dividends. Moreover, the credit of a company is much better 
 maintained where the annual operating expenses are maintained 
 nearly uniform, and where the stockholders receive fairly constant 
 dividends. Again, the public will better understand the rela- 
 tions between the public and the stockholders under constantly 
 maintained conditions than in cases where abnormally large 
 dividends are being paid a portion of the time, and no dividends, 
 or proportionately less dividends, are being paid the remainder 
 of the time. 
 
 Reserve Funds. — Where property is in first-class operating 
 condition, authorities both technical and legal generally agree 
 that, in order to ascertain the total value of the utility just and 
 proper to be used as a basis of fixing rates, there should properly 
 be added to the value of the depreciated property the amount of 
 reserve fund on hand, in cash or in property, if that fund has not 
 already been included as a part of the property being appraised. 
 It is only in case the reserve depreciation fund does not equal 
 the amount of estimated depreciation or where a fund is not avail- 
 able in cash or property that some authorities claim depreciated 
 present value should be used as a basis of rates. The difference 
 of opinion, therefore, between those who deduct from reproduc- 
 tion cost new the amount of computed or accruing depreciation 
 and those who make no deduction in determining the value 
 for fixing rates is as to the amount of the depreciation fund and 
 whether or not it is what may be termed a "liquid asset." It is
 
 28G VALUE FOR RATE-MAKING 
 
 somewhat difficult to understand exactly why this difference in 
 method and principle should be adopted simply because a cor- 
 poration may or may not have "liquid assets." If a corporation 
 has good credit it does not need quick assets because cash can be 
 quickly raised in case of emergency, and it is therefore unneces- 
 sary to keep a part of its assets "liquid." 
 
 It is frequently argued that if proper depreciation reserve 
 funds have been accumulated by a corporation, the amount of 
 such fund added to the present depreciation value of the property 
 would equal the cost of reproduction new. 
 
 As a matter of fact, the reserve funds maintained y>y a company 
 have nothing whatever to do with the value of the property on 
 which rates should be based. Reserve funds are maintained 
 for various purposes, and it is due to failure to distinguish be- 
 tween the several classes of reserve funds and their purpose, 
 together with lack of appreciation of the meaning of deprecia- 
 tion, that is the cause of the illogical attitude of many minds on 
 this subject. 
 
 Reserves are set up or accumulated for the following purposes : 
 
 (a) To provide a "surge tank" which will serve to equalize 
 the fluctuation in expenditures necessary to maintain the property 
 in first-class operating condition. The fund is provided for the 
 purpose of evenly distributing the cost of final renewals of the 
 various parts of the property, over the space of time assumed 
 to cover the period of life during which the several parts are ex- 
 pected to render effective service. This uniformity is obtained 
 by annually charging against revenue and as a part of operating 
 expense a fixed amount, for each class of property, determined 
 from a consideration of its value and assumed normal life, in- 
 cluding such additional allowance as is necessary to cover func- 
 tional depreciation, thereby making possible the maintenance 
 of constant rates for service and fixed dividends. If all parts 
 of the property were short lived, terminating within a few months 
 after installation, every utility property after the first few years 
 would have practically a uniform expenditure for renewals and 
 repairs, and in that case would require no reserve account to 
 act as a "surge tank." It will be seen, however, that, as is the 
 fact with all utilities except the largest, certain parts of the plant 
 cost relatively large; amounts of money with lives extending over 
 a period of years, making it necessary to lay aside annually a 
 flefiiiite sum, which yearly sums, with or without the interest
 
 DEPRECIATION 287 
 
 accruing thereon, together with the sum obtained by the sale of 
 scrap, will aggregate an amount, at the end of the life of the prop- 
 erty, equal to its original value, in order to permit its replacement 
 without the issuance of new capital by the corporation and without 
 unduly increasing operating expenses for the year in question, 
 thereby either necessitating temporarily high rates or compelling 
 the investors to go without dividends. Depreciation funds of 
 this "surge tank" character, provided by payments of the con- 
 sumer for the service rendered, do not return to the investor 
 any of the capital originally put into the enterprise by him ; they 
 simply maintain his investment and keep it intact, as all interest 
 on such reserve funds is, or should be, applied to and made a 
 part of the fund itself, thus helping to increase the fund, and to 
 that extent reducing the amount that must be paid in by the 
 consumer. It will be recognized that the reserve funds, of the 
 character herein being discussed, have nothing whatever to do 
 with fixing the value of the property upon which owners are 
 entitled to a return. A reduction of the original investment or the 
 cost of reproduction new, or by the theoretical amount that may 
 be estimated should, be on hand or accumulated in the renewal 
 or "surge tank" reserve fund, is confiscation of a part of the 
 property, as well as a permit to the consumer to contribute for 
 the requirements of renewals an amount less than that actually 
 necessary because calculated on a partial, instead of the full, value 
 of the property being used. Authorities have been misled, in 
 considering the subject of depreciation, by assuming that the 
 amount paid by the customers for the accumulation of a deprecia- 
 tion fund were payments made as a return to the owner of a part 
 of his investment, instead of realizing that such payments were 
 made for the purpose of equalizing maintenance and must be 
 imposed in addition to payments for normal wear and tear. 
 The total of all these payments, being simply to provide for the 
 different classes of depreciation, are used solely to maintain and 
 protect the property, without in any way reimbursing the in- 
 vestor. Where sinking fund, improperly called depreciation 
 fund, accumulations are used to pay off capital investments, the 
 difference, that is, the remainder only, after deducting the pay- 
 ment made from the original investment, should be used in fixing 
 rates, but where funds are accrued merely as a "surge tank," to 
 take care of renewals, both the fund must be accumulated and the 
 fair return paid on the investment out of contributions by the
 
 288 VALUE FOR RATE-MAKING 
 
 consumer. It would be illogical and unfair to claim the investor 
 was not entitled both to a fair return upon his property and also 
 necessary funds for its maintenance in 100 per cent, condition, 
 the same as he is entitled to other operating expenses and taxes. 
 It is difficult to see how such elementary principles have been 
 disregarded, even by some who are assumed to have knowledge 
 and experience in these matters. The California Railroad Com- 
 mission in the Palo Alto Gas Company case said: 
 
 "the company cannot consistently work for a return on its property 
 as if it were new, and also exiiect to set aside a depreciation fund." 
 
 Why the company in that case should not expect a return on its 
 investment and also the setting aside of a sufficient fund to be 
 ultimately drawn upon in maintaining its property and protect- 
 ing its investment, is difficult to see. 
 
 During the entire period that utility property is rendering 
 service to the public, the owner is entitled to a fair return upon 
 its full value, which, upon the start, would be universally recog- 
 nized to be the amount of investment fairly and judiciously made. 
 It is the part of the individuals receiving the service rendered by 
 this property, that is, the consumers, to pay to the owner what- 
 ever amount may be necessary to maintain the property and 
 keep the investment intact. The purpose of a depreciation fund 
 is to maintain the integrity of the plant and the investment. 
 Annual payments by the consumer to cover wear and tear, re- 
 pairs and renewals do not go either as dividends or return of 
 investment to the stockholder, but have their own province, 
 namely, to maintain the property. At no time during the life 
 of the property under normal conditions can there be, nor can 
 there properly be alleged to be, any impairment of the value of the 
 owners' investment. The customer is responsible for the annual 
 accruing liability on account of all classes of depreciation of the 
 plant, and it is customary to require this liability to be paid by 
 the consumer, in equal amounts regularly, as bills for service are 
 rendered. After the payment of such obligation, the consumer 
 has no further interest in the property, as long as the quality 
 of the service is maintained. Therefore, the application of the 
 amoimts paid the owner for renewals cannot in any way affect 
 the value of the property continuing to render the service desired, 
 provided always the property is maintained in condition to give 
 first-class service. Whether the payments to the owner by the
 
 DEPRECIATION 289 
 
 consumer, on account of renewals, have been deposited in a reserve 
 fund or not, makes no difference whatever in the value upon 
 which the customer must pay a return, because the owner is, 
 after payments have been made by the consumer, liable for the 
 replacements, which liability is not affected by the existence 
 of a reserve fund. The deduction of any amount equivalent 
 to an estimated fund, from original or reproduction cost in de- 
 termining the basis for earnings or rates, is purely arbitrary and 
 without justification in logic, economics or engineering. 
 
 (b) Public utilities are operating either under a limited or an 
 "indeterminate" or unlimited, franchise. Where the franchise 
 is unlimited as to duration, it may generally be assumed that the 
 utility will continue the use of its property in the service of the 
 public indefinitely. Under such conditions there exists no 
 necessity for the accumulation of a sinking fund sometimes called 
 a "depreciation fund," or "reserve fund," to pay back to the 
 investor the value of his property. On the other hand, where 
 a franchise is limited to a definite term of years, or where for other 
 reasons the life of the utility is fixed, it is necessary during the 
 period of its existence for the utility to accumulate a separate 
 and distinct fund, that at the time necessary to reimburse the 
 investor the amount of the fund, together with the cash re- 
 ceived from the sale of scrap or salvage, will equal the value of 
 the property. This fund must be accumulated from year to year 
 by payments made by the consumer for the service he is receiv- 
 ing, and has nothing to do with depreciation, renewal, or "surge 
 tank" funds, previously discussed, the sum of all of which must 
 be included as part of the cost of said service. In some cases it 
 may not be necessary that an actual sinking, or reserve, fund be 
 accumulated. In practice it may be possible at the end of each 
 year to immediately pay back to the investors the amount of 
 capital paid in by the consumer for that particular year; this 
 may be done, for example, by using the amounts collected from 
 the consumer in paying off bonds, called by allotment, or any 
 other indebtedness of the company, but it is not always possible 
 to work the matter out in this way, because of the relatively small 
 amounts paid annually, which on this account are unacceptable 
 to the investor. 
 
 Similarly, if instead of making annual payments to the in- 
 vestors on account of principle, the contributions of the consumer 
 are allowed to accumulate in a reserve fund, which may be 
 
 19
 
 290 VALUE FOR RATE-MAKING 
 
 invested, provided the investment is a "liquid asset" available 
 for promptly paying the investor in the corporation when the 
 payment becomes due, the earnings of the reserve may be either 
 added to the reserve thereby the more rapidly effecting its 
 accumulation, or the earnings may be paid to the owner direct, 
 thereby reducing by that amount the return that may be ex- 
 actetl from the consumer in paying for the service rendered. 
 
 It will be of course recognized that in all such cases as these 
 now mentioned, where the corporation can pay l)ack to its owners 
 certain portions of their investment, year by year, and the latter 
 thereby get part of their original investment out of the property, 
 the amount of such payments on account of principle must be 
 deducted from the original investment or the present I'cproduction 
 value new of the utility, in determining the sum upon which to 
 fix rates or the proper amount upon which the investor, there- 
 after, is entitled to a fair return. It is due to this very proper, 
 although perhaps somewhat exceptional application of a part of 
 revenue and the payments, by the consumer to the owner, of the 
 amounts of the original investment, improperly called deprecia- 
 tion, that has confused the lay mind and resulted in a demand for 
 deduction of all reserve funds, or theoretically computed de- 
 preciation from the original or reproduction value of the property 
 in determining present value. 
 
 (c) All utilities are liable to contingencies and must provide 
 for the unexpected. In order to carry a species of insurance, 
 many corporations provide a contingency reserve fund which will 
 amount to a relatively small percentage of the value of the 
 property. This fund is nothing more than a "safety valve" 
 which, under normal conditions, is maintained at a uniform 
 amount, perhaps requiring no accretions, but under higher pres- 
 sure conditions of financial stringency, strikes, fire, earthquakes, 
 or other similar "acts of God" the fund is a quick asset that is 
 drawn upon to meet the emergency. After the emergency, the 
 fund must be replenished either by payments from insurance 
 companies or some such source, or by contribution from revenue 
 of a portion of the payments made by the consumer for the service 
 rendered. It is to provide this contribution that small allow- 
 ances, say 1 per cent, of gross revenue, are frequently made in 
 fixing rates to be paid by the consumer. Such payments, how- 
 ever, being used simply to maintain a contingency reserve, do not 
 result in any renunieration to the original investor or in any way
 
 DErHKCIATION 2'.»1 
 
 decrease the value of the property; hence the contingency fund 
 cannot properly be deducted from original cost or reproduction 
 new in determining the value of the property used in service to 
 the public. If the fund has been accumulated out of payments 
 contributed by the consumer, after commission rule was inaugu- 
 rated, the owner of the corporation is entitled to no return on 
 the fund. On the other hand, if the fund was originally estab- 
 lished by the owner either by cash payment as an original invest- 
 ment or through the waiving of lights to a certain amount of 
 dividends, thereby permitting the gradual accretion of such 
 fund, the owner is entitled to a return on the amount of the con- 
 tingency fund, and it should be included with the value of the 
 other property in determining the total fair value to be used as 
 a basis of fair return or in fixing rates. 
 
 Depreciation Funds. — The usual method of computing and 
 making allowances for depreciation and depreciation funds are 
 what is known as either the straight line or sinking fund method. 
 Both methods are widely used and each has its ardent exponents. 
 The straight line method has been more frequently employed 
 than all other methods for the following reasons: 
 
 First. — Because the lives of much property and apparatus is 
 brief, so that any method would not differ much in the final 
 results. 
 
 Second. — The application of this method is the most simple, 
 direct and easily understood, hence naturally favored, particularly 
 by utility accountants and non-technical men who constitute 
 so large a proportion of the regulating bodies and courts. 
 
 Third. — "The profit earned by the undertaking year by year is 
 itself the full interest or increment accruing to the capital of the under- 
 taking, and it is as unsound to forestall and apply future interest (as 
 is involved by the use of the sinking fund) in a manner which operates 
 to retain the surviving value of plant in the books at too large a sum, 
 as it would be to apply interest to add to the value of unsold stock or 
 unpaid debts in which a large part of the capital of industrial undertak- 
 ings is locked up, and for this reason it is a misuse of the sinking fund 
 to apply it as the measure of the annual depreciation of plant. "^ 
 
 The Public Service Commission of New York, First District, 
 has always used the straight line method and the reasons there- 
 fore have been testified to by Ex-Commissioner Maltbie as follows : 
 
 > "The Use and Misuse of the Sinking Fund," by P. D. Le.ike.
 
 2')2 VALUE FOR RATE-MAKING 
 
 "Q. (By Chairman Hughes). May I ask you why you prefer the 
 straight line depreciation to tlie sinking fund plan? A. Whv I prefer 
 it? 
 
 Q. Yes, why you select that, considering both funds would be in- 
 vested, one in extensions to the property and the other on the side, 
 and earning an interest? A. In the first place, ordinarily that is the 
 method which is adopted and more easily understood by the company's 
 operating public utilities. Secondly, unless great care is taken in main- 
 taining the sinking fund and credits are made to that fund of the 
 interest as compounded year by year, you will not have a sufficient 
 amount when replacements become due, and it is fundamental that it 
 shall be followed by strict mathematical accuracy, or it will not work out 
 properly. 
 
 Q. That is to say it is more complicated than the other? A. It is 
 more complicated than the other. 
 
 Q. Not as easily handled? A. And in tlie third place, if retirements 
 are necessary before the end of the estimated life, or if repairs occur in 
 the earlier years for part of a group, the sinking fund method will not 
 work out because in the earlier years it grows very slowly and then in 
 the later years of the period, grows very rapidlv; consequently a little 
 deficiency in the earlier years, in the fund, will very seriously affect the 
 amount which will be found in the fund at the end of the time."^ 
 
 The Railroad Commission of Wisconsin use both the straight 
 line and the sinking fund method, preferring the latter except 
 where the life of property is rather short. The views of the 
 Wisconsin Commission are briefly set forth in the following: 
 
 "There are two methods in common use among public utilities, out- 
 side of steam railways, for determining depreciation. One of these is 
 known as the straight line method. Under it the hfe of the unit is 
 determined, and it is then assumed that during this life the depreciation 
 is uniform. For units having a life of ten years, one-tenth of their cost 
 is then set aside annually for their replacement. When of these ten 
 years, five have elapsed, the unit is supposed to be worth only one-half 
 of its original cost, or of the cost of replacing it. This method is com- 
 paratively simple and has been widely used. 
 
 The other method is based upon a slightly different theory. In 
 this case it is assumed that the amount set aside annually for deprecia- 
 tion should be invested at compound interest, and that the amount so 
 set aside, plus the interest, will be sufficient to cover the replacement 
 at the end of the life of the property. Since in this case the interest 
 also is made a part of the fund, it follows that the amount that must be 
 
 ' Testimony of Hon. Mil. R. Maltbie before Ohio Public Service Commission in re Bucy- 
 ruB LiKlit A Power Co.. Jan. and Feb., 1914.
 
 DEPRECIATION 293 
 
 set aside each year is smaller than it would be if interest was not al- 
 lowed or included. Under this method the value of the unit at any 
 intermediate year during its life is its first cost, or the cost of repro- 
 duction less the amount of the sums set aside, including the interest on 
 the same. 
 
 Under the first of these plans the drop in value is the same each year 
 during the earlier life of the unit. Under the second method the drop 
 is light at first, while the amount set aside is small, but it increases as 
 this amount grows large, and toward the end of the period it rises quite 
 rapidly. For short life units the difference between the two methods is 
 probably not very material. For long life units, on the other hand, 
 the difference may be of importance. This is especially true when there 
 are changes n the ownership. Since under the latter method the fall 
 in the value is greater in the latter than in the first part of the period, 
 it would also seem that depreciation would fall heavier on purchasers 
 than on sellers of such plants."^ 
 
 The courts have rather leaned to the simpler, more direct 
 straight line method for estimating depreciation allowance. 
 
 "The courts below determined that the relator was entitled to make 
 annual depreciation charges, amounting in the case of the borough of 
 Manhattan to the sum of $360,613.65 and in the case of the borough of 
 the Bronx to the sum of $37,435.67, for the purpose of creating a fund 
 to provide for the depreciation of its various properties; upon which 
 interest at 4 per cent., compounded, would produce a sum, at the ter- 
 mination of the ascertained physical life of the several classes of property 
 equal to the cost of the particular property. While I am, personally, of 
 the opinion that the creation of such an amortization fund furnishes 
 the best rule for adoption in such a case as this, in working out the 
 value of special franchises, the majority of my brethern entertain a 
 different view. They think that the annual allowance for depreciation 
 should be computed by dividing the values of the various kinds of tan- 
 gible property by the number of years of their respective estimated 
 physical lives and that will be the opinion of the court." 
 
 "The special term in this case, however, adopted a plan of amortiza- 
 tion upon which an annual sum was authorized to be set apart as a 
 sinking fund, which, by compounding the interest thereon for a period 
 equal to the life of the structure, tracks, engines, machinery and rolling 
 stock, would at the end of chat period create a fund sufficient to replace 
 the property. The difficulty with such holding is that railroad cor- 
 porations do not reconstruct their railroads and rolling stock in that 
 way. In order to afford proper protection to the public they are re- 
 quired to maintain a high state of efficiency both in roadbed and 
 
 1 Hill et al. vs. Antigo Water Co., 3 W. R. C. R. 643.
 
 294 VALUE FOR RATE-MA KIXC 
 
 rolling stock. Tlie relator's railroad has been in existence already for 
 about 30 years and some portion of its propertj^ has already suffered 
 from decay and use to such an extent that portions thereof have to be 
 reconstructed and made new each year. Old ties have to be removed 
 and replaced with new ones; old rails that have become worn and 
 battered have to be removed and their places supplied with new rails 
 and so the work of reconstruction progresses from year to year. It is 
 not the waiting 40 or 60 years to reconstruct, during which time the 
 amount set apart as a sinking fund may be doubled many times over 
 by compounding the interest, but it is the annual expenditure for re- 
 construction which is to be paid for at the time that the construction is 
 made. To illustrate: Suppose the average life of the tangible property 
 of a railroad, outside of the land itself, to l^e 60 years and the cost of 
 reconstruction to be $60,000,000, it would follow that $1,000,000 would 
 have to be used each year in reconstruction, and that amount would 
 have to be annually used for that purpose ; l)ut under the plan adopted 
 in this case, instead of deducting from the gross earnings the amount 
 necessarily expended for that purpose, a small fraction of that sum, 
 viz., $4,200 only is allowed to be deducted, a sum which, with the 
 interest compounded for the next 60 years, would amount to $1,000,000. 
 Under such a plan the company would be practically prohibited from 
 annually constructing a portion of its road and thus prevented from 
 keeping it in that state of efficiency which the public demands. Of 
 course tlie necessities of reconstruction vary from year to year; some 
 years it may be greater than others, but the assessors each year can easily 
 ascertain the sum required for that purpose. I think, therefore, that we 
 should adhere to the rule sanctioned in the Jamaica case, and that a gross 
 sum should be deducted annually for the purposes of reconstruction."' 
 "Of course our estimate could not be based upon the proposition 
 that the per centum set apart to cover depreciation would be deposited 
 in bank or loaned out from year to year so as to accumulate and be on 
 hand at the end of 14 years, and to be then u.sed to construct an en- 
 tirely new plant, and so on from period to period. In such a case the 
 public would not only have a service that would progressively grow 
 worse until its operations ceased altogether, l)ut it would thereafter 
 get no service at all until a new plant replacing the old could be com- 
 pleted and put into operation. The question rather has been. What 
 does experience show to be the proper average per cent, of annual 
 earnings which the company should expend in order to insure that its 
 plant at the end of 14 years will be as good as it now is, and in the 
 meantime render to the public that good service which its duty to the 
 puljlic requires?"'-' 
 
 ' People ex rel. .Manhattan Railway Company vs. Woodbury, 203 N. Y. 231, Oct. 17, 1911. 
 * Cumberland Telephone and Telegraph Co. vs. City of Louisville, 187 Fed. 637, Apr. 
 2.1. KMl.
 
 DEPRFJIA TION 295 
 
 The Pul)li(' ITtillties Act of the State of Cahfornia, Sectioii 
 49, reads: 
 
 "The Commission shall have power, after hearing, to require any or 
 all public utilities to carry a proper and adequate depreciation account 
 in accordance with such rules, regulations and forms of account as the 
 Commission may prescribe. The Commission may, from time to time, 
 ascertain and determine and by order fix the proper and adequate rates 
 of depreciation of the several classes of property of each public utility. 
 Each public utility shall conform its depreciation accounts to the rates 
 so ascertained, determined and fixed, and shall set aside the moneys 
 so provided for out of earnings and carry the same in a depreciation fund 
 and expend such fund onlj^ for such purposes and under such rules and 
 regulations, both as to original expenditure and subsequent replace- 
 ment as the Commission may prescribe. The income from investments 
 of moneys in such fund shall likewise be carried in such fund." 
 
 Commenting on this requirement of the California law and the 
 necessity of preserving payments, made on account of deprecia- 
 tion, in a fund to be held sacred to provide renewals and replace- 
 ments, Commissioner Thelen says: 
 
 "I desire to draw particular attention to the last sentence, under 
 which the income from the investment of moneys in public utilitj^ de- 
 preciation funds in this State must be carried in the depreciation fund 
 itself. In other words, the interest earned by moneys in the deprecia- 
 tion fund cannot be used for the payment of dividends or f(jr meeting 
 operating expenses. This fund, together with the interest on all 
 moneys invested therein, is a trust fund set aside for the specific purpose 
 of taking care of replacements, whether of worn out material or of 
 material which has become obsolescent or inadequate, in accordance 
 with such rules, regulations and forms of account as this Commission 
 may prescribe. As the interest is to remain a portion of the fund, it 
 would seem that ordinarily in this State the sinking fund basis should 
 be used in determining the amount to be set aside annually in this 
 fund."i 
 
 "During the term of life of the property the company gets no benefits 
 of the annual payment made by the public. The interest accretions are 
 added to the principal, and at the end of the estimated term the company 
 simply has enough money to replace the property. During the entire 
 period the company has the same amount invested or used in the 
 
 ' Decision of the Railroad Commission of California, Town of Antioch vs. Paoific C!as and 
 Electric Company, Case No. 400; Decision No. 1655, July 0, 1914.
 
 29r) VALVE FOR RATE-MAKING 
 
 public service, and therefore during the entire assumed life of the 
 property is entitled to the same amount of annual return thereon."^ 
 
 Mr. P. D. Leake, of London, an authority in accounting says, 
 regarding sinking fund methods: 
 
 "I have noticed that these devices have an extraordinary attraction 
 for many types of mind, and that too often the results expected are not 
 attained. May I impress upon you that these devices are dangerous 
 expedients in any but the most skilful hands. In practice, then, the 
 sinking fund is merely a convenient method of accumulating a certain 
 sum of money by a given date by means of annually investing a fixed 
 sum of money in the meantime. It is apt to give a sense of false security, 
 because its whole virtue depends upon its obligations being faithfully 
 carried out over the whole period, and this condition is not always 
 fulfilled. The reason is that the sinking fund discounts the future, 
 and depends upon the performance of acts in the future, sometimes 
 over a very long period, and no one can tell how in the meantime 
 circumstances may alter and conditions change. It is probable that 
 in many cases the use of a sinking fund is an altogether unwarrantable 
 draft drawn upon the future, because there is no reasonable certainty 
 that the fund, whether it be State, municipal, or commercial, will not 
 be raided before it attains its object."^ 
 
 Tiio depreciation reserve fund is simply used to equalize pay- 
 ments over a long period of time, the same way that a flywheel 
 absorbs and delivers energy at alternate intervals. 
 
 Where depreciation funds have been accumulated, the amount 
 of such funds should be added to the depreciated value of the 
 property — if such value instead of cost of reproduction new is 
 used — in determining the amount upon which fair returns are to 
 be allowed. This is the regular procedure followed by many 
 public authorities and has been the practice of the Railroad Com- 
 mission of Wisconsin for years: 
 
 "As under normal conditions investors are entitled to have their 
 property or investment kept intact, it follows that the amounts, which 
 have been properly set aside for such purposes, or for depreciation, in 
 accordance with the provisions of the law and the rules of the Commis- 
 sion, should in the instant case be included in the amount upon which 
 returns are allowed. On the other hand, amounts earned for deprecia- 
 
 • Public Service Commission, State of New York, Second District, Louis P. Fulirmann 
 VB. The Cataract Power & Conduit Company, decided Apr. 2, 1913, P. S. C. R., 2d Dist., 
 Vol. III. page 717. 
 
 The Use and Misuse of the Sinking Fund."
 
 DEPRECIA TION 297 
 
 tion but withdrawn or used for other purposes than jjrovided by law 
 shouhi not be so inchided."' 
 
 Value not Fixed by Depreciation Fund. — Where a corporation 
 is created under conditions prescribed in advance by regulating 
 bodies, or where rates include such allowance, there can be no 
 objection to the insistence upon the accumulation of deprecia- 
 tion funds out of revenue, but then such funds cannot necessarily 
 be used as a measure of value of the property upon which 
 rates are to be fixed, without regard to maintenance and con- 
 dition, even if original investment and not present value is 
 to be taken for all time as the basis of fixing rates. It will be 
 seen that the attempt to determine present depreciated value by 
 deducting from reproduction cost the amount of the accumulated 
 reserve fund — assumed to have been accumulating from the 
 origin of the corporation — results in an absurdity, because the 
 fund is based upon an estimate related to the original investment. 
 If the cost of reproduction new determined from a consideration 
 of present values is first obtained and the amount of the accumu- 
 lated reserve fund then deducted, the present depreciated value 
 will be found excessively large, in the case of a corporation, the 
 property of which has enormously increased in value, and the 
 deduction of the same reserve fund from the cost of reproduction 
 new of property that has largely decreased in value will give 
 a present depreciated value entirely too small. So that even in 
 the case of a corporation originated under public service rules 
 and regulations and adhering thereto throughout its existence, 
 cannot have its property value determined at any time in the 
 future merely by deducting from the cost the amount of the 
 accrued depreciation fund. 
 
 To further analyze the theory that present value should be 
 determined by deducting from the investment or reproduction 
 value the amount of a depreciation fund in hand, it must be re- 
 membered that the rate at which the fund is accumulated is an 
 average one, and may be excessive or less than the requirements. 
 If a newly organized corporation operating under commission 
 rule begins accumulating a fund on the basis of generally ac- 
 cepted rates of depreciation, it might be easily possible that 
 through some rather special circumstances, or contingency, 
 a larger than normal amount was required to be withdrawn from 
 the fund to provide for renewals necessary; therefore, the fund 
 
 » Superior Commercial Club et al. vs. Duluth Street Railway Co., 11 W. R. C. R. 21.
 
 298 VALUE FOR RATE-MAKING 
 
 being largely depleted or perhaps entirely wiped out, the present 
 value of the property, on the theory being considered, is reduced 
 by the amount of the computed but lacking fund, necessarily 
 expended; consequently the owners, through no fault of their 
 own, simply because they have well maintained the property, 
 are thereby deprived of a portion of the return due them on 
 which they would receive under normal conditions. 
 
 In any case, if theoretical depreciation were to be considered, 
 in determining present value, there is no logic or reason for 
 figuring depreciation on all of the property in determining the 
 amount to be deducted from investment or rejn'otluction value. 
 A large proportion of the values included in every appraisal does 
 not depreciate and therefore, such non-depreciable parts should 
 not })e reduced by an estimated amount of depreciation which is 
 applicable to other depreciable parts of the property. 
 
 "Now it seems tliat about half or more of the overhead is permanent, 
 does not depreciate, and therefore, will not be required in reconstruc- 
 tion. For instance, it is held that only in total supersession do all over- 
 head charges depreciate and that a normal depreciation allowance 
 should not be l)ased upon such assumption. It is held that certain 
 charged for engineering and supervision do not depreciate and that cost 
 of contingencies and losses during construction do not necessarily 
 have to be replaced in their entirety. Also, that interest during con- 
 struction is in the same category, while preliminary organization, pro- 
 motion, development, administration and legal expenses do not usually 
 have to be repeated in replacement."^ 
 
 The argument that the allowance of appreciation in real 
 estate values logically includes a deduction for depreciation, does 
 not follow. Increase in capital account, which is the result of 
 appreciation of land values is not in any way related to revenue 
 and operating expenses, to which alone is depreciation chargeable. 
 
 Under the Interstate Commerce regulations, as well as those 
 promulgated bj^ most of the State connnissions, and in accord- 
 ance with the practice of wcll-iun corpoi'ations iccjuirements to 
 meet both current and deferred maintenance are included as a 
 part of the oi)erating expense, to be deducted from revenue, before 
 the payment of dividends. It makes little difference whether the 
 allowance above that required for wear and tear is accunuilated 
 in a reserve fund or credited to the profit and loss account, in 
 
 ' Decision of tlio WiHoonsiii Hailroad Commission tialcd Nov. 2'i, 1913, Milwaukee 
 KIcctric Uuilwuy and Light Company. 13 W. 11. C. 1{. 22S.
 
 DEPRECIA TIOX 290 
 
 either case it may be available for taking care of renewals when 
 they have accrued. As charges on account and wear and tear or 
 renewals can be made only from revenue, there is no reason 
 why it should be confused with the capital account or deducted 
 from investment in determining value for rates. Failure to 
 provide depreciation rests with the owner who must make good 
 any deficiencies which may result from payment of dividends or 
 other diversions of revenue, if earned, and in many cases, in 
 order to protect his investment, even if not earned. 
 
 Any attempt to reduce rates by using present depreciated, 
 instead of reproduction new values, is nullified, because, logically, 
 as much higher rate of depreciation must be provided in the rate 
 as the total value of the property is reduced. That is, if 5 per 
 cent, is the proper rate to allow for providing for depreciation 
 on the basis of reproduction cost, then, if the value of the property 
 should be depreciated down to one-half reproduction cost, it 
 follows that the rate of depreciation should be 10 per cent., mak- 
 ing the charge to the consumer the same in either case, in order 
 that funds may be on hand to renew the property at the expira- 
 tion of its life. In the same way, the rate of return allowed the 
 owner should be doubled if the theoretically depreciated value of 
 the property is taken at half the reproduction value. 
 
 Moreover, there are few corporations which from the be- 
 ginning can do business and charge rates sufficiently high to 
 permit earnings large enough to provide for a depreciation re- 
 serve fund. Such being the fact with regard to newly originated 
 corporations starting under public regulation rules, how much 
 more it is evident that the value of property of long existing 
 corporations which were required neither by public authorities 
 or their own directors or stockholders to accumulate large funds 
 can now have the value of their property determined by de- 
 ducting from cost of reproduction new the amount of a theo- 
 retical reserve fund which will vary in amount depending on the 
 method used in computation, and for which, at least in any 
 large amounts, many authorities agree, there exists no necessity. 
 In the second place, it may be seriously questioned whether there 
 exists necessity for the accumulation of anything greater than a 
 contingency reserve fund, except in the case of a limited fran- 
 chise or where the life of a utility is definitely determined; in 
 such instances there must be accumulated funds sufficiently 
 large to ultimately return to the investor the full value of his
 
 300 VALUE FOR RATE-MAKING 
 
 property. In exceptional cases there may be required no depre- 
 ciation reserve funds whatsoever. A corporation that has its 
 property widely distributed, of various characters with single units 
 of relatively small value may not require any reserve, because, 
 the deterioration of property — after the first few years of opera- 
 tion — is taking place at an approximately uniform rate per annum 
 and therefore, all depreciation becomes wear and tear, and is 
 taken care of as a part of the annual operating expense; as an 
 example, the Third Avenue Street Railway Company, of New 
 York Cit}', may be cited. This property consists of nearly 300 
 miles of surface track, partly overhead and partly underground 
 trolley, with rolling stock to correspond of all sizes and types, 
 as well as storage battery cars, underground conduits, cables, 
 overhead transmission systems, car barns, substations, generat- 
 ing station, real estate, and other property extending from 
 the lower end of the Island of Manhattan up to and through the 
 Bronx and the County of Westchester, so that the exhaustion of 
 any physical property, as far as can be anticipated, will not 
 result in unduly increasing operating expenses for its replace- 
 ment, or affecting net income, or in any way jeopardizing service 
 or charges to the public. Why then should this corporation be 
 compelled to have on hand a reserve fund equal to the difference 
 between cost of reproduction new and its theoretical depreciated 
 present value, that is, a fund equal to 15 per cent., or 20 per cent., 
 of the total value, namely, a fund of from $9,000,000 to $15,000,- 
 000 for which the corporation has no use, except to be allowed 
 to earn a fair return on the full value of its property' and from 
 which the public will gain no advantage, because under public 
 regulation the corporation is compelled to render adequate and 
 reasonable service. Commission regulation always provides for 
 proper maintenance and service, and this may be enforced and 
 secured even to the exclusion of dividends. Take a case of a 
 corporation which has issued only stock and has no bonds or 
 nuMtgage indebtedness outstanding — as is not unusual in New 
 England j)articularly — in such a case the entire investment of the 
 stockholders is a guarantee of good service. Why then should a 
 Pul^lic Utility Commission insist that the public be further 
 guaranteed by additional security in the form of a depreciation 
 reserve fund. 
 
 It has l)een argued that without a reserve fund a public utility 
 owner is tempted to let his plant depreciate and to withdraw
 
 DEPRECIATION 301 
 
 from the property the funds necessary for its maintenance, but 
 this is an abnormal and unusual condition. The valuations of a 
 large number of utility properties of all kinds, made in all parts 
 of the country by a host of independent and separate appraisers, 
 result in showing that the average condition of utility properties 
 in this country is usually Ijetween 80 per cent, and 90 per cent, 
 of reproduction value new after deducting the amount of theo- 
 retically estimated and accruing depreciation. Consequently, 
 it may be stated without fear of contradiction that the con- 
 dition of the average utility plant is not run-down or giving 
 inferior service, whether or not reserve funds have been main- 
 tained. If then the physical property of a utility plant is in a 
 condition to render proper service, it is rendering it or not, 
 depending upon the wishes of the corporation officials and the 
 public authorities, but in either case the value of the property 
 is the same. Similarly, if the property is in condition to render 
 proper service, its value is the same, whether a guarantee of 
 maintenance is secured in one instance by deposit of reserve 
 funds, or, in the second instance, by the entire investment of 
 the stockholders and bondholders. Who shall say that, because 
 a given utility has not accumulated a cash reserve fund before 
 public regulation was instituted, therefore the newly created 
 Commission now has the right to deprive the corporation of a 
 part of the value of its property? The value of utility property 
 being determined and allowed by a Public Service Commission is 
 admittedly not such value as would obtain from the sale of the 
 several parts of the plant for use elsewhere, but rather that 
 particular value due to the location, suitableness and ability of 
 the parts of the plant, used together, to render the service 
 required in the community considered. If then the value of the 
 property is fixed by its value for service and not by its exchange 
 value, the full 100 per cent, value must be allowed when the 
 plant is rendering 100 per cent, service and not some proportion 
 of the full value, simply because some time in the future, in 
 order to maintain the quality of the service, the different phys- 
 ical elements must be replaced, which contingency is being 
 normally provided for in the charges made for services being 
 rendered. 
 
 It is immaterial to the consumer whether the apparatus is 
 new, in "middle life" or "aged," provided the quality of the 
 service is maintained. There is no reason why the consumer
 
 302 VALUE FOR RATE-MAKING 
 
 should expect a lower rate in the fifth year of the life of a plant, 
 simply because some of its items at that time will require renewal 
 five years earlier in the future, than at the date of beginning 
 operation. The charge against the consumer, included in the 
 rate, on account of depreciation, must be maintained throughout 
 the entire life of the plant, in order to provide earnings suf- 
 ficient to permit its renewal. If the depreciated present value of 
 the propert}^ were taken as a basis of fixing rates, when the worn 
 out parts are renewed, the investment must thereby of necessity 
 be increased, and as renewals cannot properly be charged to 
 capital account, the owner being compelled to maintain his 
 property, will not be earning a fair return on the amount of 
 difference between the depreciated value allowed, and the cost 
 new of the renewal. Even if the excess cost of the renewal 
 items, above the depreciated value originally allowed, should be 
 charged to capital account, as a practical matter it would be 
 almost impossible to increase rates to meet the requirements of 
 the increased fair return. 
 
 Investments in public utilities are made, not with the expecta- 
 tion that capital is to be paid back to the investor in relatively 
 small amounts annually, or that it is invested for a relatively 
 few years. Capital invested in utilities must necessarily be tied 
 up for a long period of time. As a matter of fact, it is not 
 possible for utility owners to sell their properties frequently, or 
 easily, except at a great sacrifice of investment. In ordinary 
 commercial enterprises, the investment in plant is small relative 
 to the value of the annual sales, with the result that the capital 
 invested is turned over from one to five times a year, in case 
 the owner so desires; with the public utility, however, the case 
 is quite different, when once started the utility must be con- 
 tinued, or the loss of practically the whole or greater part of 
 the investment will result, even though the venture may prove 
 a steadily losing one. 
 
 The investor in a pubhc utility nmst do often without his 
 interest at the start and even provide additional amounts of 
 capital for additions and extensions in order to i)rotect tlic; 
 original investment with the hope of ultimately putting the 
 whole on a paying basis. 
 
 Calculations. — As the calculation of "present value" on a 
 sinking fund basis is a somewhat complicated process, the table 
 on the following page is presented as a matter of convenience.
 
 DEPRECIATION 
 
 m.i 
 
 Tablk XII.— Depreciation Table Calculated on a 4 per cent. Sink- 
 ing Fund Basis 
 
 
 
 
 
 
 
 
 Assumet 
 
 Life 
 
 
 
 
 
 
 
 
 5 
 
 6 
 
 8 
 
 10 
 
 12 
 
 14 
 
 15 
 
 16 
 
 18 
 
 20 
 
 25 
 
 30 
 
 40 
 
 50 
 
 75 
 
 100 
 
 Age 
 
 82 
 
 85 
 69 
 53 
 36 
 18 
 
 89 
 78 
 66 
 54 
 41 
 
 92 
 83 
 74 
 65 
 55 
 
 93 
 
 86 
 79 
 72 
 64 
 
 95 
 
 89 
 83 
 77 
 70 
 
 95 
 90 
 
 84 
 79 
 73 
 
 95 
 91 
 86 
 81 
 75 
 
 96 
 92 
 88 
 83 
 79 
 
 97 
 93 
 90 
 86 
 82 
 
 98 
 95 
 93 
 90 
 87 
 
 98 
 96 
 94 
 92 
 90 
 
 99 
 98 
 97 
 96 
 94 
 
 99 
 99 
 98 
 97 
 96 
 
 
 
 1 
 
 62 
 
 
 
 2 
 
 42 
 
 
 
 3 
 
 22 
 
 
 
 4 
 
 
 99.0 
 
 
 5 
 
 
 
 28 
 
 45 
 
 56 
 
 64 
 
 67 
 
 70 
 
 74 
 
 78 
 
 84 
 
 88 
 
 93 
 
 96 
 
 98.7 
 
 
 6 
 
 
 
 14 
 
 34 
 
 47 
 
 57 
 
 61 
 
 64 
 
 69 
 
 73 
 
 81 
 
 86 
 
 92 
 
 95 
 
 98.3 
 
 
 7 
 
 
 
 
 23 
 
 39 
 
 50 
 
 54 
 
 58 
 
 64 
 
 69 
 
 78 
 
 84 
 
 90 
 
 94 
 
 98.1 
 
 
 8 
 
 
 
 
 12 
 
 30 
 
 42 
 
 47 
 
 52 
 
 59 
 
 64 
 
 75 
 
 81 
 
 89 
 
 93 
 
 97.9 
 
 
 9 
 
 
 
 
 
 20 
 
 34 
 
 40 
 
 45 
 
 53 
 
 60 
 
 71 
 
 79 
 
 87 
 
 92 
 
 97.5 
 
 99.6 
 
 10 
 
 
 
 
 
 10 
 
 26 
 
 33 
 
 38 
 
 47 
 
 55 
 
 68 
 
 76 
 
 86 
 
 91 
 
 97.1 
 
 99.5 
 
 11 
 
 
 
 
 ' 
 
 
 18 
 
 25 
 
 31 
 
 41 
 
 50 
 
 64 
 
 73 
 
 84 
 
 90 
 
 96.8 
 
 99.4 
 
 12 
 
 
 
 
 
 
 9 
 
 17 
 
 24 
 
 35 
 
 44 
 
 60 
 
 70 
 
 83 
 
 89 
 
 96.3 
 
 99.2 
 
 1.} 
 
 
 
 
 
 
 
 9 
 
 16 
 
 29 
 
 39 
 
 56 
 
 67 
 
 81 
 
 88 
 
 96.0 
 
 99.1 
 
 14 
 
 
 
 
 
 
 
 
 8 
 
 22 
 
 33 
 
 52 
 
 64 
 
 79 
 
 87 
 
 95.7 
 
 89.0 
 
 15 
 
 
 
 
 
 
 
 
 
 15 
 
 27 
 
 48 
 
 61 
 
 77 
 
 86 
 
 95.2 
 
 98.9 
 
 16 
 
 
 
 
 
 
 
 
 
 8 
 
 20 
 
 14 
 
 7 
 
 43 
 38 
 34 
 
 28 
 
 23 
 
 18 
 
 12 
 
 6 
 
 58 
 54 
 51 
 47 
 
 43 
 39 
 35 
 30 
 26 
 
 21 
 
 16 
 
 11 
 
 6 
 
 75 
 73 
 71 
 69 
 
 66 
 64 
 61 
 59 
 56 
 
 53 
 50 
 47 
 44 
 41 
 
 38 
 34 
 30 
 26 
 22 
 
 18 
 
 14 
 
 10 
 
 5 
 
 84 
 83 
 82 
 80 
 
 79 
 78 
 76 
 74 
 73 
 
 71 
 69 
 67 
 65 
 63 
 
 61 
 59 
 57 
 54 
 52 
 
 49 
 46 
 44 
 41 
 38 
 
 35 
 31 
 28 
 24 
 21 
 
 17 
 13 
 9 
 
 4 
 
 94.8 
 94.2 
 93.9 
 93.4 
 
 92.9 
 92.2 
 91.8 
 91.0 
 90.4 
 
 89.9 
 89.2 
 88.5 
 87.9 
 87.0 
 
 86.2 
 85.6 
 84.9 
 84.0 
 83.1 
 
 82.4 
 81.5 
 80.5 
 79.6 
 78.6 
 
 77.5 
 76.5 
 75.4 
 74.1 
 73.0 
 
 71.6 
 70.0 
 68.8 
 67.1 
 65.8 
 
 98.8 
 98.6 
 98.4 
 98.1 
 
 98.0 
 97.9 
 97.8 
 97.5 
 97.2 
 
 97.0 
 96.8 
 96.5 
 96.1 
 96.0 
 
 95.7 
 95.3 
 95.0 
 94.8 
 94.2 
 
 94.0 
 93.6 
 93.2 
 92.9 
 92.4 
 
 92.0 
 91.5 
 91.0 
 90.5 
 90.0 
 
 89.5 
 89.0 
 88.4 
 87.9 
 87.2 
 
 17 
 18 
 19 
 20 
 
 21 
 22 
 23 
 24 
 25 
 
 26 
 27 
 28 
 29 
 30 
 
 31 
 32 
 33 
 34 
 35 
 
 36 
 37 
 38 
 39 
 40 
 
 41 
 42 
 43 
 44 
 45 
 
 46 
 47 
 48 
 49 
 50
 
 304 VALUE FOR RATE-MAKING 
 
 The "present value," that is, the remaining vahie of propertj'^, 
 computed on a 4 per cent, sinking fund basis, may be obtained 
 at any age given in the column to the extreme right of the table, 
 by multiplj'ing the cost new of the property by the appropriate 
 percentage given in the life column for the life assumed. If 
 the property is assumed to have any scrap or salvage value at 
 the expiration of its life, the amount of same must be first de- 
 ducted from the cost new before applying the percentage from 
 the table, as above, and then that same amount must be added 
 to the product obtained, in order to secure the present value 
 including scrap or salvage. 
 
 In making estimates of the amount of depreciation existing in 
 a given utility property considered as a whole, the nature of each 
 of the elements subject to deterioration that make up that prop- 
 erty must be separately considered. Some of these elements are 
 worn out in a few years, others in 10, 20 or even 100 or 200 years, 
 depending on the material of which the element is constructed, 
 the care it has received, method of operation and effect of climate 
 and other local conditions. The first step in determining the 
 depreciated condition of the entire property is to group the sev- 
 eral elements or classes of property in accordance with their 
 several distinctive life characteristics, then to determine the age 
 of each historically, namely, by an examination of records and 
 dates of installation; next to adopt estimates of the assumed life 
 properly attributable to the several elements, and on the basis of 
 these assumptions the depreciated condition of each group is 
 computed; the values thus arrived at are modified by estimates of 
 the actual physical condition of the property as determined from 
 inspection of competent engineers. As the final step, the de- 
 preciated condition of the property as a whole, that is, the 
 "composite" remaining life value, is determined by either one of 
 two methods: 
 
 (a) The Dollar Year. 
 
 (b) The Direct Method. 
 
 In order to determine "composite life" by either method, the 
 property is all classified as to cost new, as well as scrap value, 
 from which is determined the amount in dollars, of each class of 
 property subject to depreciation. In acicordance with the dollar 
 year method and the estimated lives allotted to each class of 
 property :
 
 DEPRECIA TION 
 
 305 
 
 "There is then determined the totul number of dollars required for 
 each class during the longest life period, and this in turn is multiplied by 
 the number of years during which each dollar does duty. The result of 
 this multiplication is a figure representing dollar years, which is divided 
 between the total dollars used for the purpose of replacement during the 
 longest life period, which gives the average or composite life."^ 
 
 In order to determine the composite life of the plant by the 
 direct method, the dollars value subject to depreciation, of each 
 class of property, is multiplied by the annual rate of depreciation 
 and the sum of the products divided into the sum of the (!Ost new of 
 all the classes of property. These two methods have been worked 
 out and are shown in detail in the accompanying Tables XIII, 
 XIV and XV. 
 
 Table XIII. — "Dollar Year" Method 
 
 Class 
 
 Life 
 
 Cost of 
 reproduc- 
 tion new 
 
 Scrap 
 value 
 
 Cost 
 new 
 less 
 scrap 
 
 Times re- 
 newed in 
 75-year 
 period 
 
 Dollars 
 
 required 
 
 in 75-year 
 
 period 
 
 Dollar 
 years 
 
 A 
 
 5 
 
 $210 
 
 $0 
 
 $210 
 
 15.00 
 
 $3,150 
 
 15,750 
 
 B 
 
 8 
 
 7,124 
 
 14 
 
 7,110 
 
 9.38 
 
 66,692 
 
 533,536 
 
 C 
 
 10 
 
 17,361 
 
 153 
 
 17,208 
 
 7.50 
 
 129,060 
 
 1,290,600 
 
 D 
 
 12 
 
 26,272 
 
 
 
 26,272 
 
 6.25 
 
 164,200 
 
 1,970,400 
 
 E 
 
 15 
 
 143,470 
 
 11,920 
 
 131,550 
 
 5.00 
 
 657,750 
 
 9,866,250 
 
 F 
 
 16 
 
 65,632 
 
 33,375 
 
 32,258 
 
 4.69 
 
 151,290 
 
 2,420,640 
 
 G 
 
 20 
 
 113,336 
 
 9,239 
 
 104,097 
 
 3.75 
 
 390,364 
 
 7,807,280 
 
 H 
 
 25 
 
 43,747 
 
 7,631 
 
 36,116 
 
 3.00 
 
 108,348 
 
 2,708,700 
 
 I 
 
 50 
 60 
 
 14,337 
 1,165 
 
 
 
 
 14,337 
 1,165 
 
 1.50 
 1.25 
 
 21,506 
 1,456 
 
 1,075,300 
 
 J 
 
 87,360 
 
 K 
 
 75 
 
 21,920 
 
 
 
 21,920 
 
 1.00 
 
 21,920 
 
 1,644,000 
 
 Total 
 
 
 $454,574 
 12 per cent. 
 
 $62,331 
 overhead 
 
 $392,243 
 47,069 
 
 
 $1,715,736 
 
 29,419,816 
 
 
 
 
 
 
 $439,312 
 
 
 ,., 29,419,861 „ ,^ 
 
 Average life i yi c yog = 17.15 years. 
 
 "These methods are of the greatest importance in this connection and 
 will therefore be more fully explained. In order to illustrate the results 
 obtained in actual practice under each one of these methods, they have 
 been applied to the depreciable property of the electric lighting and power 
 plant, the composite life of which is shown in Tables XIII and XIV. 
 The electric plant was selected for this purpose because its life is short 
 and the calculations therefore comparatively few. The tables show, among 
 other things, the amounts that must be set aside annually from earnings 
 
 1 City of Ripon vs. Ripon Light & Water Co., 5 W. R. C. R. 20. 
 20
 
 306 
 
 VALUE FOR RATE-MAKING 
 
 Table XIV. — Direct Method 
 Straight Line 
 
 Class 
 
 Life 
 
 Cost of 
 
 reproduction 
 
 new 
 
 Scrap 
 value 
 
 Cost 
 
 new less 
 
 scrap 
 
 Annual 
 per cent, of 
 deprecia- 
 tion 
 
 Annual 
 amt. required 
 to cover de- 
 preciation 
 
 A 
 
 5 
 
 B 
 
 8 
 
 C 
 
 10 
 
 D 
 
 12 
 
 E 
 
 15 
 
 F 
 
 16 
 
 G 
 
 20 
 
 H 
 
 25 
 
 I 
 
 50 
 
 J 
 
 00 
 
 K 
 
 75 
 
 
 
 Total 
 
 
 $210 
 
 7,124 
 
 17,361 
 
 26.272 
 
 143.470 
 
 65.632 
 113.336 
 43.747 
 14.337 
 1.165 
 21.920 
 
 $0 
 
 14 
 
 153 
 
 
 
 11.920 
 
 33.374 
 
 9.239 
 
 7.631 
 
 
 
 
 
 
 
 $210 
 
 7.110 
 
 17.208 
 
 26,272 
 
 131,550 
 
 32,258 
 104,097 
 34,116 
 14,337 
 1.105 
 21.920 
 
 $454,574 $62,331 
 
 12 per cent, overhead. 
 
 $392,243 
 47.069 
 
 $439,312 
 
 20.00 
 
 12.50 
 
 10.00 
 
 8 . 33 
 
 0.07 
 
 6.25 
 5.00 
 4.00 
 2.00 
 1.67 
 1.33 
 
 $42 
 
 889 
 1,721 
 2,188 
 8,774 
 
 2,016 
 5,205 
 1,445 
 
 287 
 19 
 
 292 
 
 $22,878 
 2,745 
 
 25,623 
 
 ,., 392,243 ,,,^ 
 Average life ^o aya ^ 1'15 years. 
 
 Table XV. — Direct Method 
 4 Per Cent. Sinking Fund 
 
 Class 
 
 Life 
 
 Cost of 
 
 reproduction 
 
 new 
 
 Scrap 
 value 
 
 Cost 
 
 new less 
 
 scrap 
 
 .\nnual per 
 
 cent, re- 
 served on 4 
 per cent, 
 basis 
 
 -Annual 
 fund 
 
 A 
 
 B 
 
 C 
 
 D 
 
 5 
 
 8 
 
 10 
 
 12 
 
 15 
 
 16 
 20 
 25 
 50 
 60 
 75 
 
 $210 
 
 7,124 
 
 17,361 
 
 26,272 
 
 143,470 
 
 65.632 
 113..3.30 
 43.747 
 14.337 
 1.105 
 21,920 
 
 $0 
 
 14 
 
 153 
 
 
 
 11,920 
 
 .33,374 
 
 9,239 
 
 7,031 
 
 
 
 
 
 
 
 $210 
 
 7,110 
 
 17.208 
 
 20,272 
 
 131,550 
 
 32,258 
 104,097 
 .30,110 
 14,337 
 1,105 
 21,920 
 
 18.46 
 
 10.85 
 
 8.33 
 
 6.65 
 
 4.99 
 
 4.58 
 3.36 
 2.40 
 0.65 
 0.42 
 0.22 
 
 $39 
 
 771 
 
 1,4.33 
 
 1 747 
 
 E 
 
 F 
 
 G 
 
 6,564 
 
 1,478 
 3.498 
 
 H 
 
 867 
 
 I 
 
 93 
 
 J 
 
 5 
 
 K 
 
 48 
 
 
 
 Total 
 
 
 $454,574 
 
 «ri9 .•^.•<i 
 
 $392,243 
 47.069 
 
 
 $16,543 
 
 
 
 12 per cent, overhead. . . 
 
 
 1,985 
 
 
 
 
 
 $439,312 
 
 
 $18,528 
 
 
 
 
 
 
 
 Average life 
 
 10,543 
 392.243 
 
 0.04217 - 17.01 years.
 
 DEPRECIATION :W7 
 
 under eacli of these methods to cover the depreciation charges. They 
 show this for the property in each life group as well as for all the groups or 
 the plant as a whole. It will be noticed that the so-called overhead 
 charges in construction were excluded from the costs upon which the 
 depreciation charges were figured. This was done more as a matter 
 of convenience in the calculations than because some at least of these 
 overhead costs are not proper items to be covered by depreciation allow- 
 ances. The formula used in the calculation in each case is also given in 
 the respective tables. In order to shed further light on these methods 
 and enable some conclusion to be drawn as to their respective ad- 
 vantages or disadvantages, tables have also been worked out and included 
 herein which show for each method, for the period given, the respective 
 amounts placed in the depreciation reserve to cover depreciation, and 
 withdrawn therefrom to cover the cost of renewing discarded property, 
 together with the cumulative balances on hand in the reserve. In these 
 calculations it has been assumed that each part of the plant is to be 
 renewed at the end of its estimated life, and that the life of the plant 
 is therefore perpetual. It has further been assumed that the amount set 
 aside from year to year remains the same, and that there are no changes 
 in the cost of the property during the period. The computations in the 
 tables cover a period of 75 years, which period corresponds to the life 
 of that group of the property which has the longest life. This period 
 was chosen in order to show the condition of the reserve account up to 
 the time when all the property had been renewed at least once. Before 
 these methods are further explained and illustrated it should be pointed 
 out that the cost new of the depreciable property of the electric plant in 
 question amounts to $454,574; that the scrap value of the same foots up 
 to $62,331; and that the balance between this cost and scrap value is 
 $392,243. This balance represents the total depreciation, or the cost of 
 renewals that must be provided for during the composite life of the plant 
 in order to keep the investment intact. As this composite life of the 
 plant as a whole is about 17.15 years, the average amount per year is 
 about $22,878. It should also be explained that with an annual require- 
 ment for depreciation of $22,878, the total requirements for 75 years 
 would amount to $1,715,850. Under the straight line method, the 
 amount that should be set aside annually to cover depreciation is ob- 
 tained by dividing the balance between the cost new of the property 
 and its scrap value by its estimated life. As in this case this balance, 
 as stated, was $392,243, and the composite life of the plant 17.15 years, 
 the annual amount to be set aside for depreciation is $22,878. These 
 facts are illustrated in Table XIV. This table also shows that the annual 
 rate of depreciation varies from 20 per cent, for the property in the 5- 
 year group to 1.33 per cent, for the property in the 75-year group. 
 The average rate for all of these groups is 5.83 per cent, on the depreciable 
 amount. The straight line method is much more simple and direct
 
 308 VALUE FOR RATE-MAKING 
 
 than any of the other methods. It is advocated by the interstate com- 
 merce commission and for certain purposes also by the Wisconsin and 
 other State commissions. Under the sinking fund method it is assumed 
 that the amounts set aside for depreciation are invested or used at com- 
 pound interest, and that the interest so obtained also goes into the de- 
 preciation reserve. Since in this case the interest on the sum thus set 
 aside, as well as these sums themselves, becomes a part of the fund, it 
 necessarily' follows that the latter need not be as large as would be the 
 case if no interest was allowed thereon. On a 4 per cent, sinking fund 
 basis, the amount so set aside and charged to expenses is S16,543, or 
 about 4.20 per cent, on the property. When the interest on balances 
 from this time on also is included, it is found that the amounts placed in 
 the fund gradually increase. At 4 per cent, compound interest, the 
 annual allowances increase from $16,543 for the first year, to S23,545 
 for the tenth and $30,985 for the seventeenth year. When both the 
 principal and the interest allowances are thus considered, the total 
 amounts thus set aside for depreciation will be found to be considerably 
 higher than when the former alone is considered. It is seen from these 
 figures that under this method the estimated depreciation, or the pro- 
 visions therefor, are lowest at first and are then gradually increasing 
 from year to year. This is also, as a rule, the course that is followed by 
 the earnings of public utilities. It is further held that it is in accord with 
 the course of actual depreciation from the point of view of the service 
 value of the property. As a part of the provisions for depreciation is 
 made up of interest allowances on the balances in the depreciation fund, 
 it also follows that, under this method, the direct charges to operating 
 expenses for this purpose are correspondingly lower. These facts tend 
 to place this method in rather favorable light. It is also used by the 
 Wisconsin commission, when it seems to be the method that is best 
 suited to the conditions."' 
 
 From these tables it will be seen that, while the rate of depre- 
 ciation per year, on a straight line basis, varies from 20 per cent, 
 for the property having the shortest life to 1.33 per cent, for the 
 property having the longest life, the average rate of depreciation 
 is 5.83 per cent, on the composite life of 17.15 years. In a 
 similar way the annual rate of depreciation on a 4 per cent, sink- 
 ing fund basis will be found to be about 4.20 per cent, for the 
 composite life. 
 
 Attention may be called to the difference in the average or 
 composite life derived by the sinking fund method, which is 
 17.05 years as compared with 17.15 years, derived by the dollar 
 
 ' Paper, "Depreciation," by Hon. Halford Erickson, Convention of Central Water-worke 
 AwociatioD, Detroit, Mich., Sept. 25, 1912.
 
 DEPRECIATION 300 
 
 year and direct methods. It might seem at first glance as if the 
 difference was due to some error in computation. Such is not the 
 case, however, as will be seen from the following explanation. 
 In the dollar year and direct methods the average life is the num- 
 ber of years that will elapse before the property will have depre- 
 ciated an amount equal to the first cost less scrap value, that is, a 
 number of years must elapse in order that the accumulation of 
 payments made to cover depreciation will amount to the first 
 cost. In the use of the sinking fund method, the average or com- 
 posite life is the number of years required to accumulate an 
 amount equal to the first cost of the plant, less scrap value, at a 
 certain annuity, provided no withdrawals from the accumulated 
 fund are anticipated. The method used is based upon the with- 
 drawals from time to time from the fund accumulated by the 
 payments of the annuity, with its interest accruals, as becomes 
 necessary to renew the worn-out parts. To meet these demands 
 made from time to time upon the fund, in accordance with the 
 assumptions, there must always be available in the fund 
 amounts sufficient to meet the depreciation requirements. This 
 difference in principle and method has been clearly explained 
 by Dr. Alexander C. Humphreys as follows: 
 
 "By the direct scheme (no interest) the accumulation of annual pay- 
 ments in the fund must necessarily be equal at the end of any year to the 
 accrued depreciation. By the compoimd interest scheme this necessarily 
 would never be the case unless a time was reached when all the parts of 
 plant expired at the same time. There is always an overlapping of the 
 life periods of the several parts of plant, and so there will never be in the 
 fund sufficient to meet the total depreciation, though there will alwaj's 
 be enough to meet the requirements as to each part of the plant as it has 
 to be renewed. This means that when this overlapping of hfe periods 
 occurs, as it probably always would in practice, the compound interest 
 sinking fund scheme, strictly speaking, is only applicable to the case of a 
 plant operating in perpetuity. It is thus seen that the compound inter- 
 est sinking fund scheme, and the simpler scheme, which eliminates 
 interest accumulations, are essentially different in operation. In con- 
 nection with the sinking fund scheme the term 'average life' is mislead- 
 ing, whereas, by the direct scheme the true average life, if desired, can 
 be determined by the method shown in this supplementary note. 
 
 "To further illustrate that the true average life will not be the same as 
 the time during which a sinking fund scheme, if undisturbed, will accu- 
 mulate the total value of plant, we may apply a 2 per cent, and a 6 per 
 cent, sinking fund scheme to the hfe table already used. To make the
 
 310 
 
 VALUE FOR RATE-MAKIXG 
 
 comparison more apparent, I will include in the one table these two 
 schemes, the original 4 per cent, scheme and the direct scheme which 
 entirely eliminates interest : 
 
 Table XVI 
 
 Parts of 
 plant 
 
 Esti- 
 mated life 
 in years 
 
 Value of 
 plant in 
 dollars 
 
 
 Amount to be set aside eaoh year to 
 cover depreciation 
 
 G per cent. 
 
 sinking 
 
 fund 
 
 4 per cent. 
 
 sinking 
 
 fund 
 
 2 per cent. 
 
 sinking 
 
 fund 
 
 per cent, 
 no 
 
 interest 
 
 A 
 
 10 
 
 25.000 
 
 
 1,896.75 
 
 2.082.25 
 
 2,283.25 
 
 2.500.00 
 
 B 
 
 15 
 
 50,000 
 
 
 2,148.00 2,497.00 
 
 2.891.50 
 
 3,333.33 
 
 C 
 
 25 
 
 100,000 
 
 
 1,823.00 2,401.00 
 
 3,122.00 
 
 4,000.00 
 
 D 
 
 35 
 
 150,000 
 
 
 1.345.50 
 
 2,037.00 
 
 3,000.00 
 
 4,285.71 
 
 E 
 
 50 
 
 175,000 
 
 Total annual 
 
 602.00 
 
 1,146.25 
 
 2.068.50 
 
 3,500.00 
 
 Total value of plant . . ,500,000 
 
 7,815.25 10,163.50 
 
 1.3,.305.25 
 
 17,0 19. 04 
 
 
 payments 
 
 
 
 
 
 Annual payments in per cent, of 
 
 
 
 
 
 
 plant value 
 
 1.563 
 
 2.03 
 
 2.673 
 
 3.524 
 
 Years required to redeem total 
 
 
 
 
 
 value of 
 
 
 
 27.05 
 
 27.73 
 
 28.2 
 
 28 378 
 
 
 
 "It is thus seen that as the interest rate of the sinking fund increases 
 not only will the annual depreciation payment be reduced in amount, but, 
 if we stipulate that in the meantime no withdrawals shall l)e made as in 
 fact called for by the life table, then the time required to accumulate the 
 total value of plant will also be reduced. 
 
 "This seeming contradiction is the result of this stipulation, necessarily 
 introduced for this time comparison. For we must remember that the 
 amounts actually withdrawn to meet partial depreciations ('A,' 'B,' 
 'C,' 'D,' and 'E'), in accord with the life table, will be the same, no 
 matter what the sinking fund rate of interest; and as we assume that 
 these amounts are to be left in the fund and allowed to accumulate, the 
 higher the rate of sinking fund interest the greater will be the tendency 
 of these accumulations to reduce the time in which the total value (jf 
 plant will be produced. 
 
 "The higher the sinking fund rate of interest, the smaller will be the 
 sinking fund liability for each part between the several withdrawal 
 dates, therefore, the .slower the accumulation and a consequent tendency 
 between withdrawal dates to lengthen the so-called average life. While 
 this tendency ceases for each part at its withdrawal date, the tendency 
 is always in force with some of the parts, and therefore always affects 
 the scheme as a whole."' 
 
 ' Suppleriifnt No. 1 to I.octure Notes by Dr. Alex. C. Humphreys.
 
 INDEX 
 
 Absolute and theoretical deprecia- 
 tion, 239 
 Accruing depreciation not allowed, 
 
 245 
 Act to regulate commerce, 12 
 Adams Express Co. vs. Ohio, 193 
 Address delivered before American 
 
 Elec. Railway Ass'n at Atlantic 
 
 City, 70 
 Agency theory, 50 
 American Society of Civil Engineers, 
 
 committee report on water, 140 
 American Telegraph & Telephone 
 
 Com., Maryland P. S. C, 139 
 Ames vs. Union Pacific Railway Co., 
 
 131 
 Annual depreciation rates. Table X, 
 
 255-256 
 Antioch decision, 29, 51, 260, 295 
 Appellate Court of California, 246 
 Appleton Water Works Co. vs. City 
 
 of Appleton, 138 
 Appleton Water Works Co. vs. 
 
 Railroad Com. of Wisconsin, 206 
 Arnold, B. J., 280 
 Average return on depreciated 
 
 value, Table XI, 262 
 
 Black Feet Indians, in Conrad 
 Investment Co. vs. U. S., 144 
 
 Blood, W. H., testimony before 
 P. S. C. of Missouri, 100, 203 
 
 Blue Hill Street Railway Co., de- 
 cision of Mass. P. S. C, 263 
 
 Board of Gas & Electric Light Com., 
 Mass., 87 
 
 Board of Utility Commissioners of 
 New Jersey, Passaic case, 129, 160 
 
 Bonbright, Wm. P. et al. vs. W. P. 
 Greary et al., 196 
 
 Bond discount, 172 
 
 Bowers, Herbert O., vs. Conn. Co., 
 Docket No. 8, 278 
 
 Brief, Hon. Geo. S. Coleman, 189, 
 228, 230 
 
 Brief filed in behalf of the railroad 
 companies represented by the 
 President's Conference Com. be- 
 fore the Interstate Com., Sept. 1, 
 1915, 53, 104 
 
 Brief of E. F. Jones and B. W. 
 Couch, 185 
 
 Broder vs. Water Co., 142 
 
 Bronx Gas & Electric Co. case, 128 
 
 Brooklyn Gas Co. case, 128 
 
 Brunswick & Topshaw Water Dist. 
 vs. Maine Water Co., 64 
 
 B 
 
 Basis for rates, 1 
 
 Basis of value, 66 
 
 Bassett, Edward M., member of 
 
 N. Y. P. S. C, 1st Dist., in address, 
 
 43, 83 
 Beatty, Judge, 247 
 Before and after regulation begins, 
 
 27 
 Bingham and Garfield Railroad case, 
 
 45 
 
 Calculations, 302 
 
 California R. R. Com., Palo Alto Gas 
 
 Co. case, 288 
 Cataract Power & Conduit Co. (see 
 
 Fuhrman). 
 Cedar Rapids Gas Co. case, 230 
 Cedar Rapids Gas Light Co. vs. 
 
 Cedar Rapids, 181, 193, 199 
 Chapter I. Introduction, 1 
 Chapter II. Definitions, 21 
 
 311
 
 312 
 
 INDEX 
 
 Chaptor III. Fundamentals in Valua- 
 tion, 27 
 Chapter IV. Fair \'alue for Rate- 
 making, 54 
 Chapter V. Cost of Reproduction, 
 
 100 
 Chapter VI. Land, Paving and 
 
 Water Rights, 132 
 Chapter VII. Franchises, Working 
 
 Capital and Bond Discounts, 157 
 Chapter VIII. Going Value, 177 
 Chapter IX. Depreciation, 235 
 Chicago, etc., R. R. vs. Dey, 81 
 Chicago, Milwaukee & St. Paul 
 
 R. R. vs. Minnesota, 9 
 City of Beloit vs. Beloit Water, Gas 
 
 & Electric Co., 153 
 City of Chicago contracts, 124 
 City of Danville et al. vs. Southern 
 
 Railway, 123 
 City of Greenbay vs. Greenl^aj' 
 
 Water Co., 220 
 City of Helena vs. The Helena Light 
 
 & Railway Co. P. S. C. of Mont., 
 
 27G 
 City of Knoxvillc vs. Knoxvillc 
 
 Water Co., 101, 193, 267, 269 
 City of Milwaukee vs. Milwaukee 
 
 Gas Light Co., 126, 225, 279 
 City of Omaha vs. Omaha Water Co., 
 
 242 
 City of Plainfield, New Jersey, case, 
 
 49 
 City of Ripon vs. Ripon Light & 
 
 Water Co., 305 
 City of Whitewater vs. Whitewater 
 
 P. L. Co., 277 
 City of Worcester vs. Worcester 
 
 Con. Street Railway Co., 4, 49 
 Classes of depreciation, 25 
 Cleveland, Cincinnati, Chicago it 
 
 St. Louis Ry. vs. Backus, 11, 65, 
 
 192 
 Coal and Coke Railway Co. vs. 
 
 Conley, 10 
 Coleman, Hon. Geo. S., brief for 
 
 P. S. C. of N. Y., 189, 228, 230 
 Columbus Railway & Light Co. vs. 
 
 City of Columbus, Circuit Court 
 
 U. S. Southern Dist. of Ohio, 
 report of Master, 242 
 
 Commission Decisions (see De- 
 cisions of Commissions). 
 
 Commissioner Prouty of Interstate 
 Commerce Com., Spokane vs. 
 Northern Pacific Ry., 73 
 
 Comparison depreciation condition, 
 Table IX, 253 
 
 Comparison of earnings, Table I, 98 
 
 Competition, 34 
 
 Conrad Investing Co. vs. United 
 States, 143, 144 
 
 Consolidated Gas Co. case, depre- 
 ciation, 78 
 
 Consolidated Gas Co. case, pres- 
 sure, 76 
 
 Consolidated Gas Co. vs. Mayer, 70 
 
 Consolidated Gas Co. vs. New York, 
 11, 52, 103 
 
 Consolidated Gas Co. vs. Wilcox, 71 
 
 Construction schedule, 113 
 
 Contra Costa Water Co., 196 
 
 Contractor's profit, 117 
 
 Cost of reproduction, 100 
 
 Cost of reproduction defined by 
 P. U. Commissioners, 105 
 
 Cost to reproduce new, 23 
 
 Cotting-vs. Kansas City Stock 
 Yards, 71 
 
 Couch, B. W., 185 
 
 Court decisions, 76 
 
 Court decisions: 
 
 Adams Express Co. of Ohio, 193 
 Ames vs. Union Pac. Ry. Co., 131 
 Appleton Water Works Co. vs. 
 
 City of Appleton, 138 
 Bonbright, Wm. P. et al. vs. Wm. 
 
 Greary el al., 196 
 Broder vs. Water Co., 142 
 Brunswick & Topshaw Water 
 
 Dist. vs. Maine Water Co., 64 
 Cedar Rapids Gas Light Co. vs. 
 
 Cedar Rapids, 181, 193, 199 
 Chicago, etc., R. R. vs. Dey, 81 
 Chicago, Milwaukee & St. Paul 
 
 R. R. vs. Minnesota, 9 
 City of Danville et al. vs. Southern 
 Railway, 123
 
 INDEX 
 
 313 
 
 Court Decisions. — Continued. 
 City of Knoxville vs. Knoxville 
 
 Water Co., 101, 193, 230, 267, 
 
 269 
 City of Omaha vs. Omaha Water 
 
 Co., 242 
 City of Worcester vs. Worcester 
 
 Con. St. Rwy. Co., 4, 49 
 Cleveland, Cincinnati, Chicago & 
 
 St. Louis Ry. vs. Backus, 11, 65, 
 
 192 
 Coal & Coke Rwy. Co. vs. Conley, 
 
 10 
 Columbus Railway & Light Co. vs. 
 
 City of Columbus, report of 
 
 Master, 242 
 Conrad Investing Co. vs. United 
 
 States, 143, 144 
 Consolidated Gas Co. of N. Y., 
 
 Master's Report, 78, 79 
 Consolidated Gas Co. vs. Mayer, 
 
 70 
 Consolidated Gas Co. vs. City of 
 
 New York, 11, 52, 71, 103 
 Cotting vs. Kansas City Stock 
 
 Yards, 71 
 Covington & Lexington Turnpike 
 
 Road Co. vs. Sanford, 8 
 Cumberland Tel. & Telg. Co. vs. 
 
 City of Louisville, 71, 294 
 Des Moines Gas Co. vs. City of 
 
 Des Moines et al, 136, 196, 199, 
 
 208 
 Des Moines Water Co. vs. City of 
 
 Des Moines, 72, 104, 188, 195, 
 
 204 
 Emery vs. Wilson, 248 
 Fall River Gas Co. vs. Board of 
 
 Gas & Elec. Light Com., 75 
 German Alliance Ins. Co. vs. Ike 
 
 Lewis, Supt. of Insurance of the 
 
 State of Kansas, 7 
 Gibson vs. Chouteau, 144 
 Hamilton Gas Co., Ltd., vs. 
 
 Hamilton Corp. App., 213 
 Jennisson vs. Kirk, 142 
 Kansas vs. Colorado, 142 
 Kennebec Water Dist. vs. City of 
 
 Waterville et al., 28, 87, 158, 179 
 
 Court Decisions. — Continued. 
 Kings County Lighting Co. vs. 
 
 Wilcox et al, P. S. C, 46, 180, 
 
 189, 197, 208, 209, 212, 231, 233 
 Kings County Lighting Co. case, 
 
 133, 196 
 Knoxville (see City of Knoxville). 
 Light vs. United States, 143 
 Louisville & Nashville R. R. vs. 
 
 Railroad Commission of Ala- 
 bama, 135 
 Louisville & Nashville R. R. vs. 
 
 Railroad Commission, 71, 103 
 Macintosh et al. vs. Flint & Pierre 
 
 Marq. R. R. et al, 248 
 Manhattan Railway Co. vs. W^ood- 
 
 bury, 294 
 Matthews vs. Board of Corp. 
 
 Commissioners, 70 
 Metropolitan Trust Co. vs. Hous- 
 ton & T. C. R., 194 
 Miller & Lux vs. Madero Canal & 
 
 Irrigation Co., 147 
 Milwaukee Elec. Railway & Light 
 
 Co. vs. City of Milwaukee, 131 
 Minnesota rate cases, 11, 37, 65, 
 
 71, 76, 84, 101, 103, 271 
 Missouri K. & T. Ry. Co. vs. 
 
 Love, 195 
 Monongahela Navigation Co. vs. 
 
 U. S., 159 
 Munn vs. Illinois, 7, 8 
 Murray vs. Public Utilities Com., 
 
 102, 265 
 National Tel. Co., Ltd. vs. H. M. 
 
 Postmaster, 124 
 National Water-works Co. vs. 
 
 Kansas City, 69, 192 
 Norwich Gas & Electric Co. vs. 
 
 City of Norwich, 212 
 Oshkosh Water-works Co. vs. 
 
 Railroad of Wise, 227 
 Palmer et al. vs. Railroad Commis- 
 sion of the State of California, 146 
 Perth Gas Co., .Ltd. vs. City of 
 
 Perth Corp. App., 214 
 Pioneer Telephone & Telegraph 
 
 Co. vs. Westenhaver, 121, 179, 
 
 192, 196, 204, 206
 
 314 
 
 INDEX 
 
 Court Decisions. — Continued. 
 Pollard el al. vs. John Hagan et al., 
 
 141 
 Public Service Electric Co. v.s. 
 
 Board of Utility Coimnissioncrs 
 
 of N. J., 50 
 Public Service Gas Co. vs. Board 
 
 of Public Utility Commission- 
 ers of N. J., 84, 161, 162, 
 
 179 
 Reagan vs. Farmers Loan & 
 
 Trust Co., 9, 47, 215 
 Redlands Liigonia & Grafton 
 
 Domestic Water Co. vs. City 
 
 of Redlands, 247 
 San Diego Land & Town Co. vs. 
 
 National City, 11, 64, 70, 80 
 San Diego Land & Town Co. vs. 
 
 Jasper, 11 
 San Diego Water Co. vs. San 
 
 Diego, 51, 186, 247 
 San Joaquin & Kings Co. River 
 
 Canal & Irrigation Co. vs. City 
 
 of Stanislaus et al., 155 
 Shepard vs. Northern Pacific Ry., 
 
 11, 84, 103 
 Simpson vs. Shepard, 71 
 Smyth vs. Ames, 10, 65 
 Spring Valley Water-works vs. 
 
 City of San Francisco, 11, 81, 
 
 159, 187, 196 
 St. Louis & San Francisco Rail- 
 way vs. Gill, 10 
 Tutt vs. Land, 248 ^ 
 United States vs. Kansas Pac. 
 
 Ry. Co., 248 
 United States vs. Utah Power & 
 
 Light Co., 144 
 Venner vs. Urbana Water Co., 
 
 179, 194 
 Washington Reports, 89 
 Wilcox et al. vs. Consolidated Gas 
 
 Co. (see also Consolidated Gas 
 
 Co.), 52, 65, 71, 133, 158 
 Winter vs. United States, 143 
 Court of Appeals, State of N. Y., 
 The People ex rel. Kings Co. 
 Lighting Co. vs. Wilcox et al., 
 
 P. S. C, 1st Dist., 231, 233 
 
 Covington & Lexington Turnpike 
 
 Road Co. vs. Sanford, 8 
 Crowell, Chief Engineer P. S. C. of 
 
 N. Y., 2d Dist., 279 
 Cumberland Tel. & Telg. Co. vs. 
 
 City of Louisville, 71, 294 
 Curve, New Orleans Water Works, 
 
 222 
 Curves of depreciation. Fig. 1, 240 
 
 D 
 
 Decision of Railroad Commission of 
 California No. 1110 in the matter 
 of the application of North Coast 
 Water Co., etc., 51 
 
 Decision of P. S. C. of Idaho in re 
 application of Pocatello Water 
 Co., 148 
 
 Decision of Interstate Com., Spokane 
 vs. Northern Pacific Railway, 33 
 
 Decision of Mass. P. S. C. approving 
 an increase in the rates of fare of 
 the Middlesex & Boston Railway 
 Co., 107 
 
 Decision of P. S. C. of State of Mis- 
 souri, June 23, 1914, McGregoi- 
 Noe Hardware Co. el al. vs. Spring- 
 field Gas & Electric Co., etc., 
 229 
 
 Decision of P. S. C. of New York, 
 2d Dist., 18 
 
 Decision of P. S. C. of New York, 
 2d Dist. in re Fuhrman vs. 
 Cataract Power & Conduit Co., 
 3, 148, 164, 189 
 
 Decision of Railroad Com. of Cali- 
 fornia, Town of Antioch vs. 
 Pacific Gas & Elec. Co., 30, 260, 
 295 
 
 Decisions of commissions: 
 
 Board of Gas & Electric Lt. Com- 
 missioners of Massachusetts: 
 Report, 1913, 88 
 Board of Public Utility Commis- 
 sioners of New Jersey: 
 City of Plainfield, 49 
 Gately & Hurley cl al. vs. Del. 
 & Atl. T. & T. Co., 275
 
 INDEX 
 
 315 
 
 Decisions of Commissions. — 
 Continued. 
 Public Service Gas Co., Passaic 
 District, 129, 160, 203, 274 
 Interstate Commerce Commission : 
 Chesapeake & Ohio R. R. Co., 42 
 Opinion No. 1830, 40 
 Report No. 180G, 56 
 Spokane & Northern Pacific 
 
 Railway Co., 33, 73 
 Union Tanning Co. vs. Southern 
 Railway Co., 87 
 Public Service Commission of 
 Idaho: 
 In re application of Pocatello 
 Water Co., 148 
 Public Service Commission of 
 Maryland : 
 A. T. & T. Co., 139 
 Public Service Commission of 
 Massachusetts : 
 Blue Hill Street Railway Co., 
 
 263 
 Middlesex and Boston Rwy. 
 Co., 19, 107, 263 
 Public Service Commission of 
 Missouri : 
 McGregor-Noe Hardware Co. 
 et al. vs. Springfield Gas & 
 Elec. Co., 229 
 Public Service Commission of 
 New Hampshire: 
 Grafton El. Lt. & P. Co., 154 
 Manchester St. Rwy. Co., 207 
 Public Service Commission of 
 New York: 
 First District: 
 
 Bronx Gas & Electric Co., 128 
 Mayhew vs. Kings Co. Light- 
 ing Co., 229 
 Queensboro Gas & Elec. Co., 
 
 83, 127, 128, 284 
 Stadtlander vs. N. Y. Edison 
 Co., 19 
 Second District: 
 
 Fuhrman vs. Cataract Power 
 & Conduit Co., 3, 106, 148, 
 164, 189, 257, 266, 271, 276, 
 296 
 
 Decisions of Commissions. — 
 Continued. 
 Public Service Commission of 
 
 Washington: 
 Pacific N. W. Traction Co., 134 
 P. S. C. of Washington vs. Paget 
 
 Sound Elec. Rwy. Co., 89 
 Seattle, Renton & So. Rwv. 
 
 Co., 257 
 Public Utilities Commission of 
 
 Connecticut: 
 Bowers et al. vs. Conn. Co., 278 
 Railroad Commission of Cali- 
 fornia : 
 Antioch vs. Pacific Gas & Elec. 
 
 Co., 29, 30, 51, 260, 295 
 Central Calif. Gas Co., 32, 124 
 Eureka Water Co., 154 
 North Coast Water Co., 51 
 Northern Calif. Power Co., 154 
 Pala Alto Gas Co., 288 
 San Jose vs. San Jose Water Co., 
 
 227 
 San Rafael & San Anselmo 
 
 Valley Railway Co., 124 
 Wells Fargo Express Co., 95 
 Railroad Commission of Montana : 
 City of Helena vs. The Helena 
 
 St. & Rwy. Co., 276 
 Railroad Conmiission of Nevada: 
 Ely Lt. & P. Co., 276 
 P. S. C. of Nev. vs. Nev. & Cal. 
 
 P. Co., 150, 160 
 Railroad Commission of Oregon: 
 
 Home Tel. & Telg. Co., 52 
 Railroad Commission of Wiscon- 
 sin: 
 City of Beloit vs. Beloit W. G. 
 
 & El. Co., 153 
 Fuller vs. Wausau St. Rwy. Co., 
 
 242, 277 
 Greenbay vs. Greenbay Water 
 
 Co., 220 
 Hill vs. Antigo, 163, 173, 206, 
 
 242, 277, 278, 293 
 Milwaukee vs. Milwaukee G. 
 
 Lt. Co., 126, 225, 279 
 Milwaukee El. Rwy. & Lt. Co., 
 
 298
 
 316 
 
 INDEX 
 
 Decisions of Commissions, — 
 
 Cotitinued. 
 
 Milwaukee Lt., Ht. & Tr. Co., 90 
 Neenah vs. Wise. Tr., Lt., Ht. 
 
 & P. Co., 159 
 Oshkosh Water Works Co., 138, 
 
 227 
 Rhinlander P. Co., 153 
 Ripon vs. Ripon Lt. & Wt. Co., 
 
 305 
 Ross et al. vs. Burkhardt Mill. 
 
 & Elec. Co., 152 
 State Jour. Ptg. Co. vs. Madi- 
 son Gas & Elec. Co., 88, 89, 
 279 
 Superior Com. Club et al. vs. 
 
 Duluth St. Rwy. Co., 297 
 Whitewater vs. Whitewater P. 
 & Lt. Co., 277 
 State Railway Commission of 
 Nebraska : 
 Sixth Annual Report, 266 
 St. Louis Public Service Commis- 
 sion: 
 Southwestern Telg. & Tel. Co., 
 
 273 
 Union El. Lt. & P. Co., 131, 273 
 United Railways Cos., 273 
 Decisions of Courts (see Court 
 
 Decisions). 
 Decision of Washington Public Serv- 
 ice Com., Pacific N. W. T. Co., 134 
 Decision of Wisconsin Railroad 
 Com., Milwaukee Electric Rail- 
 way & Light Co., 298 
 Decision of the Railroad Com. of 
 Wisconsin in re application of the 
 Rhinlander Power Co., 153 
 Definitions, 21 
 Delaware and Atlanta Tel. iV Tolji. 
 
 Co., 275 
 Denver & Rio Grande Railroad case, 
 
 45 
 Depreciation, 24 
 Depreciation basis, 259 
 Depreciation curves. Fig. 3, 251 
 Depreciation curves, Fig. 4, 252 
 Depreciation and appreciation, bj' 
 W. H. Forse, Jr., 256 
 
 Depreciation estimates by Edwin 
 Gruhl, A. E. R. A., March, 1913, 254 
 
 Depreciation and estimates inac- 
 curate, 249 
 
 Depreciation funds, 291 
 
 Depreciation, New York court pre- 
 fers straight line, 293 
 
 Depreciation paper by Commis- 
 sioner Erickson, 308 
 
 Depreciation, Wisconsin Com. uses 
 straight line and sinking fund, 
 292 
 
 Des Moines Gas Co. vs. City of Des 
 Moines et al., 130, 178, 188, 196, 
 199, 208 
 
 Des Moines Water Co. vs. City of 
 Des Moines, 72, 104, 188, 195,' 204 
 
 Development costs, 120 
 
 Development expenses or overhead 
 charges, 23 
 
 Development of law, 7 
 
 Development of theory, 100 
 
 Direct method sinking fund. Table 
 XV, 300 
 
 Direct method, straight line. Table 
 XIV, 300 
 
 Dollar year method. Table XIII, 305 
 
 E 
 
 Eaton, J. S., 236 
 
 Efficiency in operation and utili- 
 zations, 84 
 
 Ely Light & Power Co. of Nevada, 
 270 
 
 Engineering, architect's fees, etc., 117 
 
 Engineering-Contracting, 93, 150, 205 
 
 Erickson, Commissioner R. R. Com. 
 of Wisconsin, 278, 308 
 
 Eshleman, Ex-Conmiissionerof Cali- 
 fornia Commission, 29 
 
 Eureka Water Co. of California, 154 
 
 Expenses of operation, 90 
 
 Explanatory, 21 
 
 Fair rate, 80 
 
 Fair value basis, 67
 
 INDEX 
 
 317 
 
 Fair value for rate-making, 54 
 
 Fall River Gas Co. case, 74 
 
 Fall River Gas Works Co. vs. Hoard 
 
 of Gas & Elec. Light Com., 75 
 Federal valuation, 11 
 Figure 1. Curves of depreciation, 
 
 240 
 Figure 2. Straight line and .sinking 
 
 fund curves, Gruhl, 250 
 Figure 3. Depreciation curves, 
 
 pumps, Gruhl, 251 
 Figure 4. Depreciation curves, hu- 
 man mortality, Gruhl, 252 
 Financial costs, 124 
 Fluctuating prices, 116 
 Forse, W. H., Jr., 256 
 Foster, "Engineering Valuation of 
 
 Public Utilities and Factories," 101 
 Franchises, 157 
 Franchises, working capital and 
 
 bond discounts, 157 
 Free service, 48 
 Fuller vs. Wausau St. Railroad Co., 
 
 R. R. Com. of Wisconsin, 242, 277 
 Fundamentals in valuation, 27 
 Fuhrman, Mayor vs. Cataract Power 
 
 & Conduit Co. (see under Decision 
 
 of Commissions), 3, 160, 271 
 
 G 
 
 Going value not plant operation, 22S 
 Going value not rate of return, 231 
 Going value in rate cases, 185 
 Going value relationa, Table VI, 219 
 Good-will, 24 
 Grants, 47, 158 
 Gruhl, Edwin, 254 
 
 H 
 
 Hamilton Gas Co., Ltd. vs. Hamil- 
 ton Corp. App., 213 
 
 Handbook of railroad expenses, J. S. 
 Eaton, 236 
 
 Hearings on rates of the P. S. Gas 
 Co., 203 
 
 Hill et al. vs. Antigo Water Co., 163, 
 173, 206, 227, 228, 277, 293 
 
 Hill et al. vs. Antigo Railroad Com. 
 of Wisconsin, 242 
 
 Home Telegraph & Telephone Co. 
 case, 52 
 
 How, Jared, Esq., Proceedings of 
 the American Society of Civil 
 Eng., 283 
 
 Howard, C. P., 132 
 
 Humphreys, Dr. Alex. C, 280, 309 
 
 Hutchings, J. T. , Gen. Mgr. Roches- 
 ter Railway & Light Co., 99 
 
 Garroutte, Judge, 246 
 
 Gas and Electric Light Commis- 
 sioners of Mass., 73 
 
 Gas pressure, 76 
 
 General discussion, 235 
 
 German Alliance Ins. Co. vs. Ike 
 Lewis, Supt. of Ins. of the State 
 of Kansas, 7 
 
 Gibson vs. Chouteau, 144 
 
 Gifts and donations, 46 
 
 Gillette, H. P., Discussion on Phys- 
 ical Valuation of Railroads, etc., .59 
 
 Going value, 24, 177 
 
 Going value, four meanings, 200 
 First: expenses, 200 
 Second: deficiency, 204 
 Third: income, 212 
 Fourth: comparison, 216 
 
 Illustrations, 281 
 
 Individual opinion, 278 
 
 In the matter of gas and electric 
 
 rates charged by Queensboro Gas 
 
 & Electric Co., etc., 83^ 
 Insurance, 119 
 Instruction to appraisers, 56 
 Interest, 120 
 Interest and reward, 90 
 Interstate Commerce Act, 12 
 Interstate Commerce Commission, 
 
 Report No. 1806, railroad rates, 
 
 56 
 Interstate Commerce Commission. 
 
 in Spokane vs. Northern Pacific 
 
 Rwy., 73
 
 318 
 
 IXDEX 
 
 Interstate Commerce Commission, 
 
 29th Annual Report, 18 
 Inventory, 113 
 Investment not value, 61 
 
 Jennisson vs. Kirk, 142 
 Jones, E. F., 185 
 
 K 
 
 Kansas City Water-works case, 215 
 Kansas vs. Colorado, 142 
 Kennebec Water Dist., City of 
 
 Waterville et al., 28, 57, 87, 158, 
 
 179 
 Kings Co. Lighting Co. case (see 
 
 under Court decisions), 128, 133, 
 
 197 
 Knoxville Water-works case (see 
 
 under Court decisions), 230, 267 
 
 Land, paving and water rights, 132 
 
 Land values, 132 
 
 Law and method, 60 
 
 Leake, P. D., 291, 296 
 
 Lecture Notes on Business En- 
 gineering, by A. C. Humphreys, 
 2d Ed., 1912, 281 
 
 Light vs. United States, 143 
 
 Louisville & Nashville R. R. vs. 
 Railroad Com. of Alabama, 196 
 Fed. 821, 135 
 
 Louisville & Nashville R. R. vs. 
 Railroad Com., 71, 103 
 
 M 
 
 McCarter, T. M., April 13, 1914, 3 
 Mcintosh et al. vs. Flint & Pierre 
 
 Marq. R. R. el al., 248 
 Maltbie, Ex-Commissioner, 291 
 Marks, Wm. D., 78 
 Maryland State Commission, 138 
 Master's Report, Consolidated Gas 
 
 Co. of N. Y., 79 
 
 Mathewson, Chas. F., 210 
 Matthews vs. Board of Corp Com., 
 
 70 
 Mayhew vs. Kings County Lighting 
 
 Co. (see under Court decisions), 
 
 133, 229 
 Menominee & Marionette Light & 
 
 Traction Co., 279 
 Metcalf, L., in the Transactions of 
 
 the American Society of Civil 
 
 Eng., 201 
 Metropolitan Trust Co. vs. Houston 
 
 & T. C. R., 194 
 Middlesex & Boston Railway Co., 19 
 Miller & Lux vs. Madera Canal & 
 
 Irrigation Co., 147 
 Miller, Judge of N. Y. Court of 
 
 Appeals—People ex rel. Kings Co. 
 
 Lighting Co. vs. Wilcox et al., 46 
 Milwaukee Electric Railway & Light 
 
 vs. City of Milwaukee, 131 
 Milwaukee going value, Table VIII, 
 
 225 
 Minnesota rate cases (see also Court 
 
 decisions),ll, 37,65,76,84, 101,271 
 Missouri K. & T. Ry. Co. vs. Love, 
 
 195 
 Monongahela Navigation Co. vs. 
 
 U. S., 159 
 Munn vs. Illinois, 7, 8 
 Murray vs. Public Utilities Com., 
 
 102, 265 
 
 N 
 
 National Association of Railroad 
 Commissioners, 43 
 
 National Tel. Co., Ltd., vs. H. M. 
 Postmaster, 124 
 
 National Water-works Co., 230 
 
 National Water-works Co. vs. Kan- 
 sas City, 69, 192 
 
 Neenah vs. Wisconsin Traction, 
 Light, Heat & Power Co., 159 
 
 New York Edison Co., 18 
 
 New York, New Haven & Hartford 
 Railroad Co., 279 
 
 New York Sun, Dec. 14, 1912, 122 
 
 North Coast Water Co., Calif., 51
 
 INDEX 
 
 319 
 
 Northern California Power Co. case, 
 
 154 
 Norwich Gas & Electric Co. vs. 
 
 City of Norwich, 212 
 
 O 
 
 Obsolescence, 26 
 
 Omaha vs. Omaha Water Co., ISO 
 230 
 
 Omissions, incidentals and contin- 
 gencies, 118 
 
 Opinion No. 1830 in the Matter of 
 the Investigation of Alleged Un- 
 reasonable Rates Involved in the 
 Transportation of Wool, Hides, 
 etc., 40 
 
 Opinion and decision of Railroad 
 Com. of Wisconsin vs. Milwaukee 
 Light, Heat & Traction Co., 96 
 
 Oregon & California Railroad land 
 grant, 47 
 
 Original cost, 22 
 
 Oshkosh Water-works Co. vs. 
 Railroad Com. of Wisconsin, 138, 
 227 
 
 Other bases, 18 
 
 Overhead charges, 125 
 
 Palo Alto Gas Co. decision, Railroad 
 Com. of California, 288 
 
 Palmer et al. vs. Railroad Commis- 
 sion of the State of Cal. et al., 146 
 
 Paper "Depreciation," by Hon. H. 
 Frickson, Convention of Central 
 Water-works Ass'n, 308 
 
 Passaic gas case (see also Public 
 Service Gas Co.), 129 
 
 Paving, 135 
 
 People ex rel. Kings Co. Light- 
 ing Co. vs. Wilcox et al., composing 
 P.S. C, 1st Dist., 46, 133, 180, 
 189, 196, 208, 209, 212 
 
 People ex rel. Manhattan Railway 
 Co. vs. Woodbury, 294 
 
 Perth Gas Co., Ltd. vs. City of 
 Perth Corp., 214 
 
 Petition of Grafton Electric Light 
 & Power Co., decided Feb. 3, 
 1914, by New Hampshire P. S. C, 
 154 
 
 Physical or structural value, 21 
 
 Pioneer Tel. & Telg. Co. vs. Westen- 
 haver, 121, 179, 192, 196, 204, 206 
 
 Pollard, John, et al. vs. John Ilagen 
 et al., 141 
 
 Preface, v 
 
 Preliminary expenses, 122 
 
 Present value, 22, 70 
 
 Principles involved, 54 
 
 Principles of Valuation, by R. H. 
 Whitten, 231 
 
 Privy Council of Eng., going value, 
 213 
 
 Proceedings of the American Water- 
 works Ass'n, Table VII, 224 
 
 Proceedings of the 23d Annual 
 Convention,Nat.Ass. Ry. Com., 43 
 
 Promotion, 123 
 
 Prouty, 35-37 
 
 Public Service Commission of Mass., 
 19, 263 
 
 Public Service Commission of Ne- 
 vada vs. Nevada & Cal. Power Co., 
 150, 160 
 
 Public Service Commission of New 
 York, 1st Dist., accounts, 122 
 
 Public Service Commission of New 
 York, 2d Dist., 106, 164, 257, 
 266, 271, 276, 278 
 
 Public Service Commission of Wash- 
 ington vs. Puget Soimd Elec. 
 Railway cases, 89 
 
 Public Service Electric Co. vs. 
 Board of Utility Commissioners 
 of N. J., 50 
 
 Public Service Gas Co. case, 129, 
 160, 203, 274 
 
 Public Service Gas Co. overheads, 
 Table IV, 129 
 
 Public Service Gas Co. vs. Board 
 of P. U. Com., 84, 160, 162, 179 
 
 Public Utilities Act of California, 
 295 
 
 Public utiHty decisions, 273 
 
 Purpose affects valuation, 42
 
 320 
 
 INDEX 
 
 Q 
 
 Queens Borough case, 127, 128 
 
 Queens Borough case, overheads, 
 Table II, 127 
 
 Queens Borough, Kings County, 
 Brooklyn Gas, overheads. Table 
 III, lis 
 
 Queens Borough, in re Gas & Elec- 
 tric Co., 83, 127, 128, 284 
 
 Report of Railroad Commission of 
 
 California, 29, 30, 32, 51, 95, 124, 
 
 154, 227, 2(>0, 288, 295 
 Report of Railroad Securities Com., 
 
 123 
 Reproduction new, 109 
 Reserve funds, 285 
 Right of regulation, 4 
 Ross et al. vs. Burkhardt Milling & 
 
 Elect, Power Co., 152 
 
 R 
 
 S 
 
 Railroad Commission of California, 
 29, 30, 32, 51, 95, 124, 154, 227, 
 260, 288, 295 
 
 Railroad Commission of Oregon in 
 re Home Tel. & Telg. Co., 52 
 
 Railroad Company's brief before 
 Interstate Commerce Com., 53, 
 104 
 
 Railroad Securities Commission, 
 promoter's profit, 123 
 
 Reagan vs. Farmers Loan & Trust 
 Co., 9, 47, 215 
 
 Redlands, Lugonia & Grafton Do- 
 mestic Water Co. vs. City of Red- 
 lands el al., 247 
 
 Report of Gas & Electric Light 
 Commissioners of Mass., 88 
 
 Report and Decision of the Rail- 
 road Commission of Cal., Thomas 
 Monohan as Mayor of the City of 
 San Jose vs. San Jose Water Co., 
 227 
 
 Report and Order of Board of P. U. 
 C. in the matter of Gately & Hur- 
 ley el al. vs. Del. & Atl. Tel. & Telg. 
 Co., 275 
 
 Report and Order of the Interstate 
 Commerce Commission in the 
 matter of investigation and sus- 
 pension of advances in rates for 
 the transportation of coal by the 
 Chesapeake & Ohio Railroad Co., 
 etc., 42 
 
 Report of the Public Service Com- 
 mission, State of New Hampshire, 
 207 
 
 San Diego Land & Town Co. vs. 
 
 Jasper, 11 
 San Diego Land & Town Co. vs. 
 
 National City, 11, 64, 70, 80 
 San Diego Water Co. vs. San Diego, 
 
 51, 186, 247 
 San Joaquin & Kings Co. River 
 
 Canal & Irrigation Co. vs. City of 
 
 Stanislaus el al., 155 
 San Rafael & San Anselmo Valley 
 
 R. R. Co., 124 
 Scrap or salvage value, 22 
 Seattle, Renton and Southern Rail- 
 way Co. rate case, 257 
 Senate Committee, 39 
 Service value, 22 
 Shepard vs. Northern Pacific Ry., 
 
 11, 84, 103 
 Simpson vs. Shepard, 71 
 Sixth Anrmal Report of the Nebraska 
 
 State Railway Com. to the Gov- 
 ernor, 266 
 Smyth vs. Ames, 10, 65 
 Some legal aspects of regulation of 
 
 P. S. Corp., 211 
 Southern Pacific Railway, 87 
 Southern Pacific Railway grant, 158 
 Southwestern Telg. & Tel. Co., 273 
 Spring Valley Water-works vs. 
 
 City of San Francisco, 11, 81, 159, 
 
 187, 196 
 Statlander in re vs. N. Y. Edison 
 
 Co., 19 
 State Journal Printing Co. vs. 
 
 Madison Gas & Electric Co., 88, 
 
 89, 279
 
 INDEX 
 
 321 
 
 St. Louis Public Service Commis- 
 sion, 131, 273 
 
 St. Louis & San Francisco Railway 
 Co. vs. Gill, 10 
 
 Stevens, F. W., address, G9, 100 
 
 Straight line and sinking fund 
 curve, Fig. 2, 250 
 
 Summarized elements of reproduc- 
 tion cost, 112 
 
 Superior Commercial Club el al. vs. 
 Duluth Street Railway Co., 2«)7 
 
 Superseded plant, 130 
 
 Supplement No. 1 to Lecture Notes 
 by A. C. Humphreys, 310 
 
 Supreme Court of Iowa, 181, 187 
 
 Supreme Court of New Jersey, 161 
 
 Supreme Court of United States, 
 4, 7, 8, 9, 10, 11, 47, 49, 64, 65, 
 69, 71, 76, 81, 101, 131, 136, 142, 
 143, 144, 156, 158, 159, 180, 183, 
 190, 192, 193, 195, 199, 208, 215, 
 230, 242, 248, 267, 269, 271 
 
 Swain, Prof. Geo. F., 279 
 
 Table I. Comparison of earnings, 98 
 
 Table II. Queens Borough case, over- 
 heads, 127 
 
 Table III. Queens Borough, Kings 
 Co., Brooklyn Gas, overheads, 128 
 
 Table IV. Public Service Gas Co., 
 overheads, 129 
 
 Table V. Working capital, 171 
 
 Table VI. Going value relations, 219 
 
 Table VII. Years to acquire one 
 dollar, 224 
 
 Table VIII. Milwaukee going value, 
 225 
 
 Table IX. Comparison depreciation 
 condition, 253 
 
 Table X. Annual depreciation rates, 
 255, 256 
 
 Table XI. Average return on de- 
 preciation value, 262 
 
 Table XII. Depreciation Table Cal- 
 culated on 4 Per Cent. Sinking 
 Fund Basis, 303 
 
 Table XIII. Dollar year method, 305 
 
 Table XIV. Direct method, straight 
 
 line, 306 
 Table XV. Direct nictlKxi, sinking 
 
 fund, 306 
 Table XVI. Sinking fund rate und 
 
 life, 310 
 Taxes, 122 
 Testimony of Hon. Milo R. Malt})io 
 
 before Ohio P. S. C. in re liucyus 
 
 Light & Power Co., 292 
 Thelan, Coinmi.ssioner of Railroad 
 
 Commission of California, 259, 295 
 Town of Antioch vs. Pacific Gas & 
 
 Electric Co., 29, 30, 51, 260, 295 
 Trustee theory, 53 
 
 U 
 
 Uniform system of accounts, P. S. C. 
 
 of N. Y., 1st Dist., 122 
 Union Electric Light & Power Co. 
 
 of St. Louis, 131, 273 
 Union Tanning Co. vs. Southern 
 
 Railway Co., 87 
 United Railways Co. of St. Louis, 
 
 273 
 United States vs. Kansas Pac. Ry. 
 
 Co., 248 
 United States vs. Utah Power & 
 
 Light Co., 144 
 Unit prices, 114 
 Use and Misuse of Sinking Fund, by 
 
 P. D. Leake, 291, 296 
 
 Value, 21 
 
 Value in appraisals, 68 
 
 Value of service, 86 
 
 Value not fixed by depreciation 
 fund, 297 
 
 Valuation Act of Congress, 12 
 
 Valuation of Public Service Corp., 82 
 
 Valuation of Public Utilities, by 
 R. H. Whitten, 101 
 
 Valuation of Public Utility Proper- 
 ties, by Henry Hoy, 173, 218, 237 
 
 Valuation of Railroads, by Hon. C. A. 
 Prouty, 35, 37 
 
 Van Fleet, Justice, 51
 
 322 
 
 INDEX 
 
 Venner vs. Urbana Water Co., 179, 
 194 
 
 W 
 
 Washington Laws, 1911. 214 
 
 Washington Reports, 89 
 
 Water law, A. S. C. E., 140 
 
 Water rights, 139 
 
 Wearing value, 22 
 
 Wells Fargo Express Co. rates, 
 
 California, 94 
 Westchester Lighting Co., 279 
 Whitten, R. II., S2, 101, 231 
 
 Whitney, Asa, going value, 205 
 Wilcox et at. vs. ConsoHdated Cas 
 
 Co., 65, 71, 133, 158 
 Wilson, President Woodrow, 3 
 Winter vs. United .States, 143 
 Working capital, 165 
 Working capital. Table V, 171 
 
 Years to acquire one dollar, Table 
 VII, 224
 
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