Part 26

The first conception, for fixing the cost of the several items, is to consider the railway to be reproduced as being non-existent at the time the estimate is made, but having the environment which then exists along the operated railway, although that environment may be largely of the railway's own creating. The cost of the right of way is to be fixed as ungraded and unimproved property attached and forming a part of the adjoining improved property, which adjoining property will be entitled to receive, in addition to the market value of the land taken, all consequential damages due to the taking off of the right of way in the form and location that the land has actually been taken, and for the purpose of railway construction and operation. This adjoining property is to give credit on the consequential damages for the incidental benefits which it derives, if any, from the construction and operation of the railway.

In fixing these values, the drift of public sentiment—the bias of juries of view and of trial juries—at the time the estimate of cost of reproduction is made must be considered, since that sentiment may affect enormously the cost of the right of way. The amount to be paid for a right of way is in the end that which a condemnation court will award. The question as to whether or not the right of way was originally donated can no more enter into the determination of the cost of reproduction, for the purpose of lessening the estimate of cost of acquiring the right of way, than the fact that donations of lands or bonds (or of convict labor and slave labor, as in the South prior to 1860) made by governmental authority or private enterprise, at the time of the original construction, can be used to reduce the reproduction cost of the excavation made in the formation of the roadway.

No rule as to the sale of property for commercial purposes in the vicinity of an operated railway can be rightfully adapted as covering the line as a whole. While the cost of right of way through farm or timber lands bears a general relation to the value of those for agricultural purposes, where improvements thereon bear but a small proportion to their total value, this relation is wholly wanting in the cost of a right of way through a village or city or at any point where the improvements on the property bear a large proportion to its total value. The relation is also wanting where a right of way is obtained through agricultural lands devoted to special purposes, like that of country homes for the rich. It is also wanting where the right of way is taken out of the narrow river lands in the Appalachian Mountains, where the total value of the whole farm is dependent on the small acreage of flat land along the river bank. The general rule of prefixing a constant to the current selling price of lands, in order to determine the estimated cost of right of way, should be limited to agricultural and timber lands, and to those which, owing to their extent, the carving out of the right of way does not wholly destroy for the continuation of agricultural and timber operations.

For villages and cities, and for lands devoted or adapted to special purposes, an accurate estimate of the cost of reproduction of the right of way can be determined only by a specific investigation of the conditions in each community. While it is difficult to conceive all the activities and sentiments which have growth in, from, and of railway operation, as being in existence without the railway, it is only through such an assumption that one can estimate correctly the make-up of the items of cost of reproducing a railway as such railway may now exist. To assume that the railway, not existent for the purpose of estimating the cost of reproduction, will now receive the donations of land and moneys that were made half a century ago, is merely going back to a determination of what the road has actually cost; and that is contrary to the intent of the theory of the cost of reproduction. The conception of a parallel line is not correct, for it imposes thereby a further burden on properties which have already contributed to the public good, probably to an extreme extent, and gives an abnormal cost for right of way, as shown when a railway seeks to enlarge its terminals in a crowded community, or to find a new entrance into a populous city.

So, too, in estimating on the formation of the roadway, one must consider the roadway to be reproduced as being obliterated—all cuts and borrow-pits refilled, and all embankments and spoil banks removed from the right of way—but all other lines of transportation, except the railway to be reproduced, must be considered as being in existence as they actually are at the date when the estimate of cost of reproduction is made, and that such other lines of transportation are available for bringing in machinery, tools, teams, materials, and supplies for the construction of the railway to be reproduced. It is only by such an assumption that the benefit of the improved means and methods of construction now prevalent can be obtained; but it is not permissible to estimate for the construction of a railway with different grades, alignment, roadbed, widths, or with different materials than that of the railway to be reproduced merely because such construction at this day might be actually cheaper or better than to construct it in exact duplication. For example, if the rock cuts on the roadway to be reproduced be only 18 ft. wide, with ¼:1 slopes, one must not figure on the greater economy of steam-shovel excavation, because the steam shovel cannot be worked in cuts of that width; nor can the spoil from such cuts be carried long distances to eliminate a possible solid-rock borrow originally made elsewhere, because long hauls are practicable in steam-shovel work, but wanting in excavations where the mule is the transportation force. So, too, it is not permissible to estimate on reinforced concrete bridges to take the place of more costly cut-stone arches, if cut-stone arches are the structures that have been actually built. The idea of cost of reproduction is not synonymous with the idea of the cost of building a railway capable of serving the same transportation purpose. If all our railways were to be built anew, in the light of our present knowledge, and with our present traffic offerings and financial resources, vast changes would be made in the character of construction. The physical fact of existing construction prevents a theoretical substitution of what is the best construction for any community, together with its costs for the construction which was actually made years ago.

In the event that an estimate of reproduction costs be made for a State as a whole, or for a great railway system as a whole, the conception of reproduction is modified so that the construction may take the form of progressive construction, the principal lines being built first and the less important lines afterward. This method will require the estimate for interest during the construction period to be greater.

The money cost of the seasoning and the adaptation of the roadway to such a condition as will permit heavy trains to be run at high speeds, is great, but the amount is not readily ascertained. An estimate of cost of reproduction, to be true, must consider this item; and probably the more usual method of ascertaining it is to assume it to be an amount in some proportion to the cost of the excavation. This proportion will vary with the character of the material through which and of which the cuts and fills are made, and with the methods of construction necessarily adopted. There are many railways on which this cost will exceed 25% of the total cost of excavation.

After the estimate has been made, including the item for seasoning and adaptation, there should be added a contingent fund to cover the omitted work, consisting of small borrow-pits and ditches, undetermined foundations, unexpected conditions encountered, unavoidable "force account" work, minor changes of streams and highways, damages to adjoining lands due to the methods of construction and to diversion of water, etc. This item will not exceed 5% of the cost of the roadway if the estimate be accurately made.

The more convenient form into which an estimate of cost of reproduction of a steam railway is to be put is to follow the sub-accounts, as prescribed by the Interstate Commerce Commission for Expenditure for Road. Each item given in that accounting has a place in the estimate. These comments are confined to the items covering the roadway, namely, Right of Way and Station Grounds, Grading, Tunneling, Bridges, Trestles, and Culverts.

HENRY C. ADAMS, ESQ.[28] (by letter).—To the writer this paper seems to be the most complete and comprehensive discussion of the general question of valuation of property invested in public service industries that has come under his notice. It is especially important in that it is a summary of the discussion on this most difficult subject during the past ten years, and the writer thoroughly agrees with the general conclusions reached by Mr. Riggs.

There is one point, however, which might possibly have been developed more completely, and that is the treatment of discounts, which presents itself from time to time in the general discussion. Mr. Riggs quotes with approval the following:

"If a company can market its 50-year, 4 per cent, bonds at 90 per cent. of par, it means that the company's credit is on a 4½ per cent. basis; that it could market a like security paying 4½ per cent. at par."

This is, of course, correct as far as the mathematics of the proposition is concerned, but it seems to overlook that peculiar psychology of the market which enables a corporation to secure a larger amount of actual cash for a given interest annuity when bonds are sold at a discount than when they are sold at par.

Aside, however, from the accuracy of the above quotation and of Mr. Riggs' apparent acceptance of it as the final word on discounts, one may ask if it recognizes all the elements necessarily involved in a discussion of the problems raised by discount financiering. From the literature of the subject one may read the following claims: Discount is a measure of the risk involved in a new enterprise; discount is a market adjustment that reflects the current value of money; discount is a sacrifice of principal for a slightly reduced interest annuity; discount is a dividend declared before the dividend is earned; and many cases are cited in which a discount is merely a promoter's fee for services rendered.

The writer does not care to discuss at this time these various points of view from which discounts may be regarded. They are mentioned merely to suggest that the subject is not as simple as some writers seem to think. Any valuation of public service industries, from whatever point of view it may be regarded, must, from the nature of the case, touch the problem of fundamental equities; and one of the elements of this problem which has not as yet been fully analyzed is this element of discounts. From the point of view of taxation, such an analysis is not perhaps essential; but if the valuation is to be used as a basis of determining reasonable rates, or as a measure of reasonable capitalization, it seems to be essential.

The writer is sure this discussion will not be construed as in any sense a criticism on Mr. Riggs' paper; it is rather a suggestion of an unwritten chapter in the literature of valuation. The American Society of Civil Engineers is to be congratulated in securing from one of its members so complete and satisfactory a discussion of the principles and methods for the valuation of public service corporation property.

CARL C. WITT, M. AM. SOC. C. E. (by letter).—The appraisal of the railway property in Michigan was a wonderful performance in a great many ways, not the least of which was the thoroughness of the work, considering the short time available, and the writer desires to express his appreciation of this paper, as it is a valuable addition to the meager literature on this subject.

More recent appraisals, made by States traversed by the same railway systems as those involved in the Michigan appraisal, have been made with a freedom from opposition by railway companies due to the educational effect of this pioneer work. Particularly is this true of the recently completed appraisal, by the Board of Railroad Commissioners of South Dakota, of the physical property of the railways in that State, of which work the writer was the Engineer in charge. No opposition was met; in fact, some of the railway companies had established regular departments for furnishing inventories and appraisals, had completed the necessary field work in South Dakota before the inventory had been requested by the State, and were able to furnish a very complete appraisal in a short time after the request for it was made.

This appraisal was made in compliance with an act of the Legislature of 1907, which required the Board of Railroad Commissioners to ascertain the true cash value of all the property of every railroad company in South Dakota used in the operation and maintenance of their respective roads. No attention was paid to the purpose of the appraisal, but one of the first uses made of the information thus secured was in the litigation following the passage of an act by the Legislature of 1909, prescribing a maximum passenger fare of 2 cents per mile on all railroads operating within the State. In connection with a rate case of this kind, some questions have been raised regarding proper bases for land values, the use of an item for adaptation and solidification as an element of physical value, the value of the intangible assets, etc.

The lands of all railway companies were appraised at a cost to reproduce or re-purchase at the time of appraisal, regardless of the original cost of the property. The sales method was used for determining the market value of adjoining property. There has been a very large land movement in South Dakota in the last five years, and as most of the country is prairie, with similar soil over large areas, it was not difficult to determine the average market value of the land for farm purposes, at the date of the appraisal, and the gradual trend of values for five years previous to that date. An average multiple of 250% was used to arrive at the cost of reproducing or purchasing the right of way. This multiple was based on investigations made of recent right-of-way purchases, and inasmuch as there are no large terminals in South Dakota, the same average multiple was used throughout the State for both town and farm property, investigation showing that town property could be secured for slightly less and farm property for slightly more than the average multiple used.

In each supplemental appraisal the land values will be corrected to correspond to the changes in surrounding values, as the railway company is entitled to any increase, due to natural causes, based on the cost to reproduce at the time of appraisal. This is a well-established theory, as shown by Mr. Riggs.

No allowance was made for the item commonly known as "adaptation and solidification," except in the item of contingencies and in the consideration of the present value of the ballast. In some recent appraisals, large sums, based on a percentage of the cost of grading, have been allowed for this item. While there is no question that large sums of money are expended in maintaining a safe track on a new bank, and that this expense gradually diminishes as the roadbed becomes solid, due to the pounding of the trains and the action of the elements, this expense is, and properly so, charged to maintenance, and is paid for out of the operating revenues. Now, in the trial of a rate case, exhibits showing the operating expenses, including maintenance charges, are introduced, and to include this same item in the appraisal of the physical property leads to a duplication, for if the passenger or shipper pays for this maintenance charge, it should not be counted as an item of physical value as a basis for determining what is a reasonable rate.

The case is similar to that of a locomotive: When new, it is kept in the vicinity of the shops, because trouble from lack of proper adjustment and weak parts is likely to develop, and the maintenance charges may be much higher than a few months later when the machine has "found itself" and, as an operating machine, is more efficient than when new. However, no one will insist that it has an added physical value in dollars and cents, or that the excess cost of repairs and maintenance during its early life should be added to its cost of reproduction now; in fact, it is a second-hand machine, and the maintenance charges must be paid for out of its use.

Generally, when a roadbed is turned over to the operating department by the construction department, it is in good line and surface, and if an appraisal were made at that time its condition would be 100%; but as soon as it is placed under traffic, it begins to depreciate, as shown by the fact that it requires constant attention to keep it up. If the roadbed is cross-sectioned at each station and actual quantities calculated from cross-section notes, there would be no depreciation, but if the grading quantities are calculated from profiles of the line, as constructed some time previously, and for a standard width of sub-grade, with a percentage added for shrinkage, and allowance made where banks have been widened, etc., it will probably be found to exceed the actual measured quantities, because the action of the elements in washing the slopes, the wearing of the shoulders of the embankment due to foot traffic, etc., will show some depreciation in quantities. It is common practice to carry the item for grading over to the present-value column at 100%, or, with no depreciation. This practice, together with the present condition of the ballast due to maintenance, and that part of contingencies which covers washing of slopes, filling of ditches, sink holes, etc., certainly takes care of all adaptation and solidification which should enter into a valuation of physical property.

No appraisal was made of the intangible assets. A great many arguments have been advanced for and against such an appraisal, and in South Dakota it was held that the earning ability of any corporation due to its franchise, strategic location, efficient organization, going-concern value, etc., while perhaps an element of value to be considered in a transfer of the property or if assessed on an income basis, should not enter into a valuation which would be used for determining a just and reasonable return on the investment, because the greater the earning power the greater would be the return, and that this condition would produce a never-ending increase in returns; whereas, when the returns reach a point at which they will not only pay a fair dividend on the investment, but take care of any depreciation in the physical condition of the property and make all needed improvements in roadbed, buildings, and equipment, demanded by the traveling public, shippers, increased traffic, or natural causes, they should be kept to that point. There are several hundred miles of railway in South Dakota which have been built out of the surplus earnings of the parent corporation—in other words, with money supplied by the traveling and shipping public—but which are owned by the railways and on which they may earn another surplus for constructing more extensions, etc., etc.

The original South Dakota appraisal, as of June 30th, 1908, on forms similar to those used in Minnesota, has been supplemented by yearly appraisals corrected for all additions and deductions made during the fiscal year. For this purpose a new set of forms[29] was prepared, with the various items classed in accordance with the "Classification of Expenditures for Road and Equipment," as prescribed by the Interstate Commerce Commission, and arranged so as to facilitate showing the yearly changes.

R. A. THOMPSON, ASSOC. M. AM. SOC. C. E.[30] (by letter).—This paper is considered by the writer to be the most complete treatise ever written on the valuation of public service corporation property, and the author deserves the sincere thanks of the entire Engineering Profession and all others interested in this most important question. Its presentation is most timely, in view of the agitation, particularly on the subject of railroad valuation, which is now engaging the attention of Congress and the law-making bodies of the several States, as it contains much valuable information relative to decisions of Courts, in addition to clear and concise expositions of the methods in vogue for the appraisement of corporate property, etc.

It is a fact—rapidly coming to be recognized by legislative and judicial bodies—that the prescription and regulation of tolls, charges, and assessments against public corporations cannot be made systematic and intelligent unless there is provided some estimate of the value of the property involved, based on the cost of its replacement or reproduction. Particularly is this true of railroads; and such regulation of the affairs of these corporations as has heretofore been essayed by State and National commissions, has generally been on illogical bases, unsatisfactory alike to the proponents and the companies. Results have been had, it is true, after a fashion, but there have been endless disputes and litigation, with the prime questions involved no nearer solution than before. One has but to contemplate the varied and often antagonistic legislation promulgated by the several States, relating to corporation management, and the many rulings and decisions of the different courts and commissions on the subject of regulation, assessment, and adjudication of corporate rates, revenues, taxes, and tolls, to become convinced of the complicated and tangled condition of the situation, and to realize the necessity for the early establishment of some logical basis on which to establish the fabric of corporate control.

While it is not maintained that an appraisement of the physical property of public service corporations will be the panacea for all such ills, the writer firmly believes with the author that such appraisal, as a beginning, is absolutely necessary, and when effected on some fair and reasonable basis, will contribute largely to the successful solution of many of these intricate problems.

With the estimate of the physical value of a property before it—which represents money actually invested, together with such accruals to costs as it may be determined that the owner is reasonably entitled to have considered—any Court, tribunal, or commission is in a better position to mete out impartial justice, whether it be the regulation of a rate, the assessment of a tax, or the imposition of a fine.