Part 25

The points in favor of inspection to determine the physical condition of the object to be valued are convincing, where the structure may be readily inspected. Mortality tables mean little without a history of maintenance. With perfect maintenance there would be no physical depreciation.

_Maintenance versus Depreciation._—Depreciation and maintenance are interdependent, so much so that some engineers have advocated dropping the term, "depreciation," and substituting "deferred maintenance." A little thought will make this clear. While this term would not apply in the case of a single rail or car, it is not illogical when applied to a system, built and renewed piecemeal and maintained at a certain standard of usefulness, that is, on all well-managed undertakings of magnitude, units are constantly being replaced, thus maintaining a standard of efficiency. This standard, on the entire system, is usually found to be between 70 and 90% of the cost of reproduction. Some items are even improved, and the cost is charged to the maintenance account, such as that referred to in the paper as "consolidation and adaptation" of roadbed; and only a few, such as steel rails, steadily and progressively become less useful, and even these have a bottom value, that of scrap steel. Nor are examples numerous where all the rails are laid at one time, and they are extremely rare where all are replaced at approximately the same time. When the rails on a street or section are renewed, the cost cannot properly be charged to capital account, except in so far as the new rails are of a more valuable type than the old ones; for, if this were done, there would be no limit to the capitalization as time goes on. Furthermore, the moment it is admitted that, by reason of a change in the art, we may have depreciation through obsolescence, we admit that through a change in the art we may have appreciation through the opposite of obsolescence. This being the case, the use of "mortality tables" to determine present value is misleading, unless it is done with the full itemized accounts of maintenance, which are seldom, if ever, available. The author's position in regard to the need of inspection of each item is well taken.

_Dead versus Live Properties._—These, perhaps, are not happy expressions, but they serve to emphasize a vital distinction which must be made in the valuation of properties. The difference may be as great as between a corpse and a man; here, also, the distinction is hard to define. We say the soul has departed, or the spark of life is extinguished, but these expressions do not contain a satisfactory scientific definition. So, as Mr. Riggs points out, the physical property of a going business may not be valued as so much junk, even if the non-physical values are to be determined separately.

_The Franchise a Contract._—The Courts hold a franchise to be a contract, something often forgotten, both by the public and by corporations. The speaker, however, understands this only to mean, even where the franchise is in perpetuity, that the property of the corporation cannot be taken for public use without just compensation. In a sense, then, there can be no such thing as a perpetual franchise. Using the word franchise with its restricted meaning, the unreasonableness of the rates may be measured by the value of the franchise.

_Physical versus Non-Physical Values._—The following division has been made by the author between physical and non-physical property, for the purpose of valuation:

"That the Physical Value, or present value of the physical property, should fairly represent the actual capital invested in the property at the date of appraisal; that it should be made up of the sum of the various elements which constitute the cost of reproducing the property together with any appreciation which may have been added to any of them, less all depreciation.

"That the Non-Physical Value is the difference between the 'fair value' as defined by the Courts, or the reasonable value of the property as a business or producing property, and the physical value, or actual present worth; and that the only proper method for determining such values involves a study of income accounts.

"This Non-Physical Value may be: positive, or a value in excess of the physical property, or negative, or less than the physical value. In the case of a property having a negative intangible value, a deduction should be made from the physical value."

This division is convenient but arbitrary. It is the division of an engineer rather than of an economist; for these so-called non-physical values are like the breath of a man's life; without them, the physical value is like the discarded body. Again, the use of negative non-physical values, while convenient, may not be wholly logical. These remarks are not directed at Mr. Riggs, for he is careful to say that he is dealing only with active enterprises, and not with those which are inert, and the speaker realizes that he is not attempting primarily to build up a logical argument, but to formulate certain rules to overcome practical difficulties met by all who have attempted valuation work. As many who have not given this matter much thought are apt to be misled by the distinction made between physical and non-physical values, they should bear in mind that the line between them is like the equator, an imaginary one.

_Water._—"The water is as much a part of the cost of putting that line there as the rails," remarked a corporation official, of admirable character and wide experience, pointing to a trolley line from the window of a Pullman car; and, bearing in mind what he meant by "water," this is undoubtedly so. The cost of promoting the enterprise, the discount on the hazard, the loss of interest during its infancy, the labor of building up the undertaking—these are all real elements of cost, and may remain in the property as value, but, like all other items of cost, they have their reasonable limits, which, in each individual case, can be determined within narrow bounds.

_Purpose of a Valuation._—As Mr. Riggs points out, there are four reasons for a valuation: Taxation, rate-making, purchase, and control of the issue of securities, one of which is usually the primary cause for the valuation being made; and he argues that there can be but one "fair value" of the physical property, whichever of these reasons may prompt the appraisal. This is fundamental, for "fair value" is used in the sense of true value, which, to the writer, seems to be a more apt expression. It is rather surprising that it does not appear in the paper. Its use, of course, is old; in the Constitution of New Jersey, 1875, we find: "Property shall be assessed for taxes under general laws, and by uniform rules, according to the true value." Each of the three matters, taxes, rates, and authorized capitalization, are interdependent and, in the long run, cannot be considered separately. This can be emphasized by a _reductio ad absurdum_: Modern civilization is so dependent on transportation by rail that unquestionably all taxes could be raised by assessment on the railroads, if these roads were allowed to fix their rates and were protected in the collection of them; but how would this method differ from that of the Romans, of farming out the collection of taxes? Not materially, and no one advocates a return to that method. This is absurd, but it serves to emphasize the relation between taxes and rates. Taxes can only come from the rates.

_Overhead Charges versus Unit Values._—There is much in various parts of this paper concerning overhead charges, but very little about the items considered in determining the unit values or unit prices used; and does not the latter greatly affect the former? For example, in discussing the Michigan appraisal, the author says:

"For many items, such as clearing, grubbing, earthwork, masonry, etc., the price was fixed by agreement during the discussion at a figure which represented the fair average cost of this particular item during the 5-year period preceding the appraisal."

The "fair average cost" under what conditions? This word "cost" is understood by different men in as many different ways as the word value. Mr. Riggs very clearly gives the items included in "fair value" as finally arrived at by him, but it would seem to be as important to define "fair cost" as used in arriving at the unit prices, for otherwise the chain has a weak link.

What may be considered a fair cost per unit of measure for a particular item differs greatly: First, with the point of view and breadth of horizon of the man stating such cost; and second, with the methods of letting contracts and accounting with which he may be familiar, as applied to such items of work. Because of the first, a fair average unit cost may mean one thing to a contractor, another to a division engineer, still another to a chief engineer, and a fourth to a manager or consulting engineer; and because of the second, the understanding of the term may differ among men of the same class. All of this quite aside from what may be termed the personal equation of the individual. Thus the subject of overhead charges can only be discussed profitably in the light of knowledge concerning what has already been included in fixing the unit prices used. For example, the element of hazard common to all construction, but differing in degree on different classes of work, may be included in the unit cost used, or it may be added as a percentage to resulting sums, but it cannot rightly be included twice. This is equally true of other elements of cost of a similar character.

The foregoing is pertinent, for any valuation will probably be attacked in the Courts, and the unit values will be one of the most tempting points for assault, for the very reason that this wide difference of understanding in regard to cost, and particularly in regard to unit costs, exists. This same difference of understanding is usually the reason for the wide difference in unit costs testified to by able engineers and, consequently, for the distrust often felt for such testimony. The methods followed in taking expert testimony usually work to make "confusion worse confounded." The judge or layman, hearing two engineers testify to widely different unit prices as a fair average cost for certain work, forms a low opinion of their judgment, or worse, whereas the real difficulty may, and usually does, lie in a different understanding of the meaning of the term "cost," or "unit cost." To the speaker, this seems to be the weakest point in an admirable paper.

_Paving._—Whether the value of the paving between and for a space outside of the tracks is an element of value in a street-car line, or whether the cost incidental to the construction and maintenance is in the nature of a tax, is a much disputed point in all valuations of street-railway properties, and an important one, for it may amount to $15,000, or more, per mile. It is interesting to remember that the custom of requiring street-railway companies to maintain the pavement between the rails and for a space of about 2 ft. outside of them, which has become almost universal, developed during the use of horses to draw the cars, the animals causing great wear on that portion of the street. This question of values is a difficult one. It would seem that the most tenable position is that: If the fee to the pavement is not in the company, and if the rule concerning cost of reproduction less depreciation is to be followed, the cost of taking up and relaying the pavement is an element of value in the physical worth of the track, for it would be impossible to reproduce the track without incurring the cost of such work.

S. D. NEWTON, ASSOC. M. AM. SOC. C. E. (by letter).—The general scope of this paper is admirable. The author's views and definitions are unusually sound, clear, and forcibly expressed. To one minor detail, however, the writer is unable to subscribe. Referring to "the physical property element of value," he states that:

"This consisted of those things which are visible and tangible, capable of being inventoried, their cost of reproduction determined, their depreciation measured, and without which the property would be unable to produce the commodity on the sale of which income depends."

Take the case of an industrial spur for some minor industry along a line of railroad. It is often a question in the minds of the management whether or not the car-load business done by such an enterprise is sufficient in quantity to warrant the expense of a spur track. There are probably other facilities in the neighborhood which could be used to take care of this business at the expense of some inconvenience; in a large proportion of cases, the railroad will handle the business anyway, and the spur can in no sense be called a necessity. Still, it is visible, tangible, and capable of being inventoried, and should be included in an inventory of the property the same as any track or section of track belonging to the Company. This may also be said of an extra settling basin or filter bed in the case of a water-works plant. If such basin or bed were not in existence, and a leak should occur in the original plant, the business of supplying water to its customers could, in all probability, be carried along in some manner until the break could be repaired; nevertheless, such a tank or bed is desirable, and its value should most certainly be included in an inventory.

Take the extreme case of a piece of machinery which is utterly broken down or so far out of date as to be entirely worthless for the purposes for which it was designed. Yet such machinery has, at least, a scrap value, and as such it should be included in the inventory as part of the tangible assets of the concern at the date in question.

Of course, in many instances, certain interests endeavor to have inventoried items which should either be omitted altogether or included at a much reduced valuation from that sought to be placed on them, and, in such cases, the very best judgment of the appraising engineer must be called into play in order that injustice may not be done to either party; but to say, as Mr. Riggs' definition virtually does, that nothing should be inventoried which can, either with or without inconvenience, be dispensed with, is absurd, and the writer does not believe that such is the meaning the author intended to convey. Probably, if the word "economically" were inserted in the definition, it would more nearly represent the proper idea.

WILLIAM V. POLLEYS, M. AM. SOC. C. E. (by letter),—In his very thorough and painstaking paper Mr. Riggs states that it is confined to a discussion of methods for arriving at a correct figure of cost, and disclaims any intention of considering the propriety of using said figure when reached.

Inasmuch, however, as he devotes the next eight or ten pages to a dissertation on law, political economy, rate-making, finance, and advice to railroad employees, with a word of encouragement to the good, and firm reproof to the bad ones, it is fair to assume that he intends this disclaimer in a Pickwickian sense, and that the real intent of the paper is to show that the physical valuation of property is, with certain determinative, corrective factors, a proper standard for gauging taxation, bond issues, and kindred evils.

Is it not a fact, however, that taxation is based on a much more intangible structure, and that the net earnings must necessarily have more to do with it than the physical valuation of the property—whether it be that of a wicked public service corporation, or that of an honest haymaker—rather on what their property can produce, than on what it would cost to produce the property? Is it not rather a battle of business acumen between the taxer and taxee, a battle which, among other things, is regulated more or less by the fact that an extreme in either direction will bring disaster to one or both, followed by the inevitable reaction and readjustment?

Take, for instance, an extreme case: A manufactory is erected on comparatively worthless ground. A million dollars or more is invested in a plant, with the result that surrounding real estate values go up with a bound. Supposing that the manufacturer has not made any previous arrangements for immunity, and the assessors are both acute and honest, the property will be taxed for a large figure, which tax, if the factory is making money, will be paid, with more or less grumbling, up to the economical breaking point. Suppose that, owing to a sudden permanent change in business conditions, it becomes impossible to operate this plant, and it is abandoned. A corps of experts may be thrown into the mill, before the last employee has left the building, and may carefully scrutinize and caliper the machinery, count the bricks in the wall, tap the stay-bolts in the boilers, and bore into the furniture to see whether it is solid or veneer, and when they are through and their figures are all in, they have not arrived at anything that is of the slightest use as a basis for a bond issue or taxation, and very little that would be of use for sale. In such an extreme (but by no means unheard-of) case physical value bears no relation to real value.

This is not to say that a physical valuation is without worth, and even great worth in some cases; it is merely offered as an opinion that the physical value is in many (and probably most) instances a very treacherous guide to the real value—a far poorer guide, as a general rule, than the accounting department; a minor quantity, in fact.

It seems doubtful whether there is a scientific way of arriving at the true value of a going property by the physical-valuation route. There is too large a percentage of values which, being intangible, are matters of judgment. At best, the determination of value must be that of opinion, and the worth of that opinion hinges principally on the practical qualifications and disinterestedness of the person who gives it.

Unfortunately, or fortunately, as the point of view may be, the disinterested person is not apt to be qualified, nor the qualified person to be disinterested, and it seems extremely probable to the writer that, while weapons may be changed and excuses vary, the tax war will be waged as of yore, and the fool and his money will continue along diverging paths until something more ingenious than physical valuation is invented, however well the valuation may be made.

C. P. HOWARD, M. AM. SOC. C. E. (by letter).—While there may be no material differences of opinion as to the principles on which a physical valuation should depend, such a detailed description of organization and methods as that presented by the author should be of great service to others undertaking similar investigations.

It may not be amiss, however, to mention certain features affecting the non-tangible values which should be more fully considered in any general discussion of the subject.

The author calls attention to one or more particulars in which the methods of the Michigan appraisal may "fail as a method of determining a value for use as a basis of rate-making." Later, after quoting various court decisions, he dismisses this phase of the subject with the words: "In view of these dicta, it is needless to argue whether a rate of 6% or 10%, or 15%, or more, be reasonable."

A value for purposes of rate-making might more properly be called a "permissible value." The writer holds no brief for the corporations, and would not like to fall under the imputation of being "apparently incited by, either the direct interest of corporations, * * * or an effort to confuse the subject of valuations," but will venture the following, which, while it does not exactly represent any particular case, it is hoped may be recognized as an illustration drawn from life.

A, B, C, and their associates, being familiar with a certain territory, its resources, transportation facilities, and growing development, believe that the time has come to build another railroad through their State or States. They have made careful estimates of the amount of tonnage that may be expected from the development of its mines, timber, farms, etc., and conclude as follows:

_First._—The road, completed along the most approved lines, will cost, with equipment, $50,000,000.

_Second._—It will take five years to construct and equip the road and put it in fair running order.

_Third._—The traffic, when fully developed according to their hopes and expectations, will eventually afford at usual tariffs a handsome profit, say, from 8 to 12% per annum on the capital invested. This condition, they believe, in all human probability, will be attained in from 5 to 10 years after completion.

_Fourth._—That half the traffic anticipated will pay 5% on the investment.

_Fifth._—They are obliged to admit (though the chances of this are so remote as to be in their opinion negligible) that, due to unforeseen causes, obstruction, competition, etc., there is a possibility that, as has so often happened in the past, the enterprise may prove a financial failure, or that the period of prosperity may be postponed so far into the future as to amount to practically the same thing.

Here is a bold undertaking; but were it $5,000,000 instead of $50,000,000, the conditions would be essentially the same. Nevertheless, they have the courage of their convictions and go ahead.

Now, with all the risks and uncertainties attending an enterprise of this sort, if the ultimate profits were limited in advance to 5 or 6% on the capital invested, less depreciation, who but the Government itself could afford to build a railroad?

Evidently, when an existing railroad makes small additions from time to time to extend or take care of its business, the risk is not so great. Such extensions will continue more or less under any limitations.

For rate-making, it is evident that an appraisal based on earnings will utterly fail of its purpose if made during the lean years immediately following construction. If made some years later, when the property has begun to pay, the risk and necessary financial loss of the lean years should be remembered, as any one building a road in the future will necessarily have the same problems to meet, together with the expenses of interest, depreciation, loss from operation, etc., both during the construction and the lean years following, all of which must properly be considered a part of the real cost of constructing and developing a property.

J. E. WILLOUGHBY, M. AM. SOC. C. E. (by letter).—The determination of the cost of reproducing the property of any steam railway involves, together with other items, an estimate of the present cost of:

_First._—The acquirement of the right of way, to the extent, in the form, and on the location of that held in connection with the railway to be reproduced;

_Second._—The construction thereon of the roadway, to the form and dimensions, and of the materials which the roadway to be reproduced exhibits; and

_Third._—The seasoning and adaptation of the roadway to the state of perfection which the roadway to be reproduced exhibits at the time the estimate of cost of reproduction is made.