Part 27

Although the author's experience in valuing corporate property has been principally in connection with the Michigan appraisal of railroads, and to him is largely due the credit for devising methods for, and carrying forward to successful completion, this thorough and most excellent work, it is refreshing to note his inclination to give credit to the work of others along the same line in other States, which, it is to be regretted, has not always been the case with writers on this subject. There is no doubt that the work of the Michigan and Wisconsin Boards of Appraisal—conducted under the advice and direction of some of the most eminent and talented engineers and economists in the United States, and practically without regard to expense—is the most complete and perfect of its kind heretofore attempted; yet there are many features in regard to the organization and execution of its details about which there may be an honest difference of opinion, as viewed by those who have been similarly employed.

It is but natural—as suggested by the author—to find the "individual" character of the appraiser (which has been moulded by his environment, training, and former service) reflected in his opinion, and this would be most probable in the organization for, and carrying on the work of, appraising a railroad property, which involves consideration of practically every phase of engineering and economics. The judgment of any man is essentially warped along the lines of his experience, and he is necessarily biased and prejudiced in favor of or against certain practice. As a consequence, therefore, it is not reasonable to suppose that any one man, or set of men, can formulate a system for valuing corporate property which will be perfect in all its details, and be free from objection and criticism.

The writer was employed for a number of years as Engineer for the Railroad Commission of Texas, and had charge of the valuation of railroad property under the Railroad Stock and Bond Law of that State. A paper on the methods used by this Commission was prepared by him and published by the Society.[31] This Stock and Bond Law was enacted in 1893, and the railroads then existing were valued in 1894 and 1895. The average value of 8,860 miles was $15,844 per mile. This valuation was made by Charles Corner, M. Am. Soc. C. E., now Resident Engineer of the Rhodesia Railways, South Africa, and Mr. H. J. Simmons, now General Manager of the El Paso and Southwestern Railway System. The actual cost of this work is not available, but is estimated at about $2 per mile. The engineers making the appraisal secured maps, profiles, and all available information from the offices of the railroad companies, including all the construction records and estimates of quantities which were preserved. Appraisal was made only after one of the engineers had made a personal examination on the ground, accompanied by assistants to aid in measuring structures and estimating quantities.

All valuations made since 1895 have been of new railroads making application for issuance of securities, and in all cases the deeds for right of way and depot grounds, the contracts for construction, the actual quantities of construction of all kinds, the plans and specifications for all structures and construction, and all other information which the engineer desired, were submitted by the railroad companies to enable an accurate appraisal of the value of the property to be made. It is not possible for valuations of this character to be made under more favorable circumstances. Up to October, 1909, more than 3,500 additional miles had been valued, and in all cases the estimates limited the securities which the companies might issue.

Writers on railroad valuation have generally been inclined to discredit the work of the Texas Railroad Commission and the system of appraisal used by it. One writer, of more or less prominence, has referred to it as the "cheap" method. While it may be true that other appraisals have been more expensive, it is a fact that those of the Texas Commission have served their purpose well, and the railroads, as a rule, have made little complaint. As a matter of fact, it is highly probable that the valuations of railroad property made by the Texas Commission have been of greater utility, as far as the public is concerned, than those of all other States combined, and, at the same time, no injustice has been done the railroads.

It appears that those who have interested themselves in investigating the Texas method of railroad valuation—including the author—have failed to construe the real meaning and intention of the Stock and Bond Law. Apparently, it was passed for the purpose of limiting railroad indebtedness—and is referred to by Mr. Riggs as serving only this purpose—but while its effect has been to accomplish this most successfully, its enactment carried with it a deeper significance.

This law was passed at the same time as the General Railroad Commission Act of the State, which gave to this Board absolute control over all freight rates and tariffs, and also other powers not possessed at that time by any other State commission. The decisions of the highest Courts at that time laid stress on the right of carriers to maintain rates which would afford a reasonable return on stocks and bonds outstanding. Hence, to delegate the regulation of rates to any tribunal by any law which did not carry with it also the right to supervise and restrict mortgage indebtedness to some reasonable extent, appealed to the legislators as being essentially ineffective. The effect of the law has been to reduce steadily the average outstanding stocks and bonds of the railroad companies of the State from an average of $40,802 per mile in 1894 to $31,910 in 1909—and this, too, in the face of a recognized increase in the physical value of the properties—thus depriving the railroads of one of their most potent weapons of offense when contending against the Commission's orders. It is a matter of common knowledge that the indebtedness per mile of railroads of other States has increased greatly during this period. It is also a fact that the railroads of Texas have, except in rare instances, contended that injustice has been done them in the enforcement of this law, and the market value of their stocks and bonds has steadily risen. Also their physical condition is on a par with that of railroads in other Southern and Western States, and their incomes from operation are as substantial. The practice of "watering" their securities has been effectually stopped, as regards local issuance, and any interest which might have accrued on such securities has been saved to the public.

It has been contended that the Texas valuations of 1894-95 were too low, and did not, even at that time, represent the fair value of the properties. This is perhaps true to a certain extent, but it must be remembered that the costs of materials and construction then were less than at any time before or since; and, viewed from the present-day standpoint, they seem to have been inadequate. It must also be considered that real estate values throughout the entire State were very low, compared with present values and with those of lands in other States. Although the writer admits that the margin was very narrow, still he is of the opinion that the valuations as made represented closely the cost of reproduction of the physical properties at the time.

The valuations of 1894-95 stand to-day on the Commission's records as "the value of the property," except in cases where there has been application and necessity for re-valuation. The machinery of the law did not provide that these appraisals should be kept "up to date." The mortgages on these railroads are still outstanding, and there has been no call for another appraisal, except in a few instances. The Commission has decided that in its opinion the "present value" of any of the railroads already appraised is represented by the original valuation plus the value of all permanent improvements and betterments added. This principle has been carried out with those railroads which have applied for re-valuation for any purpose, and the Commission has admitted the same in testimony which it has given before the Courts.

Since the appraisals which the Texas Commission makes are primarily for the purpose of limiting indebtedness, and the carriers are entitled to have these at least equal the cost of their property—the investment with certain additions to cover promoters' profits—no consideration can be given to depreciation of structures and equipment, although the application for valuation and process of issuing of securities may be had several years after completion. The writer holds that there is strong argument in favor of not taking into account "depreciation," and of estimating the value of the property as being entirely "new," whatever purpose the valuation is proposed to serve. This is apparent, as already stated, when the valuation is to serve as a basis for limiting the issue of stock and bonds. Is there any logical reason why a valuation for this purpose should not also serve—as far as it pertains—as a basis for taxation or for regulating freight rates? As far as the State is concerned—and to be consistent—should not "one" valuation serve all purposes?

Suppose that a State should create a board clothed with powers of rate regulation, taxation, and authority to restrict indebtedness, and also prescribe that it should appraise the value of the property of the railroads, and use that appraisal as the basis for its acts. Would it be logical for that board to make and apply one system of valuation for one purpose and another system for another purpose? Manifestly, it would have declared that a valuation was a "valuation" for all purposes, at least as far as the physical property was concerned; and, when devising a method for making its appraisals, it should incorporate therein all the elements of value which might apply logically to either purpose. The writer believes that "depreciation" of roadbed and structures would have no place in such an appraisal, on the one hand, nor its negative, but fully as intangible and difficult of concrete estimate, "adaptation and solidification of roadbed," on the other.

It should not be understood that the writer maintains that taxation boards should not go beyond the valuation of physical property to arrive at a final basis for assessment. There are certain intangible elements which should be taken into consideration when taxing property, chief of which is the net income. It is only as far as physical valuations apply in either case that he considers that there should be uniformity.

He does not approve at all of incorporating in an estimate of the physical value of a railroad property such an element as "adaptation and solidification of roadbed," which is credited with so much importance in the Minnesota valuation. In the first place, such an element is incapable of being measured in tangible terms and reduced to a dollars-and-cents basis; second, it cannot be reproduced in the sense that other property is reproduced, and its value does not appear in the capital account of the railroad; and third, it results from the action of the seasons on the one hand, and the working over of the roadbed by the maintenance forces on the other, the cost of which appears in operating expenses. One is constrained to believe that the engineer who insists on incorporating such an element in an appraisal of the physical value of a railroad is hard put to find material with which to swell his estimate. When noting the large difference in value per mile of the railroads of Minnesota, as compared with those of Michigan and Wisconsin—adjoining States—it would appear that undue prominence had been given to this and similar factors.

The writer's experience as appraising engineer for more than 10 years with the Texas Railroad Commission, and for the past 2 years as a construction engineer—having built about 160 miles of railroad in Oklahoma and Texas—confirms his belief that, in the absence of actual figures of cost, right of way and other railroad real estate should be appraised at but little in excess of the market value of abutting property. The practice of the Texas Commission has been to add from 25 to 50 per cent. The conditions under which railroads were built in Michigan, Wisconsin, Iowa, and Minnesota cannot have been radically different from those in the Southern and Western States. In Texas it has been a rare instance when a railroad has had to purchase all of its right of way. Also, contiguous lands have greatly increased in value since the advent of the railroads. It would appear highly illogical to advocate that these increased values should be multiplied by 3—or even 1½—and used as a basis for taxing the railroads on the one hand, or taxing the public on the other, by permitting indebtedness to be issued against it, the interest on which the latter must pay. The railroad recently constructed by the writer traversed fertile and thickly populated areas, already quite well served with transportation facilities. Only a small fraction of the necessary real estate was purchased by the railroad company, and only in a few cases of such purchase did it pay largely in excess of the market value of the land—and these were where the road interfered with houses and other farm improvements. In cities and towns, land was acquired at practically its fair market value. For rural property, the ratios used by Professor Taylor in the Wisconsin appraisal appear to be quite fair, but in cities they are too high—especially for the Southwest. The Minnesota ratios appear to be unreasonably high.

Any appraisal of the physical value of railroads—in the absence of figures as to their actual cost—is necessarily only approximate, and is correct only within certain limits. Especially with regard to the old roads, where original cost data cannot be had, the values applied to property and construction must be largely speculative. It is impossible to build two railroads in the same territory, on the same specifications, for the same amount; yet, on the basis of cost of reproduction, an appraisal board must apply the same value to each.

The writer believes that unless there is more uniformity as to methods of valuing corporation property, as between the States, all valuations will be more or less discredited, as they should be, by the Courts. It is to be hoped that this paper will be generally discussed by the Profession, and will lead to the adoption of more uniform methods.

CHARLES H. LEDLIE, M. AM. SOC. C. E. (by letter).—The following is suggested as a method of procedure for determining the fair and equitable value of a property:

1st.—Examine carefully the statutes governing corporations of the class under examination.

2d.—Form an opinion as to whether or not the locality can support such a property, by inquiry regarding the different businesses carried on, bank clearings, railroad facilities, what the surrounding country produces, etc.

3d.—Find from the archives of the company a general description of the property, from its conception to the date of appraisement.

4th.—By close examination of the minute books, directors and executive committees, there can be ascertained all the details of organization, issuing of stock, bonds, and other forms of indebtedness, contracts for equipment, supplies used in the construction, etc.

5th.—Obtain from the general manager or the superintendents an explanation of the details of operating and maintaining the property, including the different classes of service, rates, etc.

6th.—Go over the property, examine it carefully, and talk to any and all employees from whom it is thought that any information can be gained.

The foregoing will give a general knowledge of the property under examination, and will enable one to begin the real work. The examiner's assistants must be competent and experienced men.

7th.—Examine all the vouchers, from the beginning of the company down to the date it began operation; classify their contents under the respective heads for the different classes of material used in the construction, for example, pipe, engines, cable, etc.; then prepare blank tables for each heading, having columns for size, quantity, prices, and total; and abstract each voucher. Do the same with the vouchers for labor, general office salaries, general expenses, interest, taxes, legal, etc. This, when completed, will give the detailed cost, as shown by the vouchers.

Next check the vouchers back through the books, and draw up a statement, which will show the total book cost and, no doubt, will differ from the voucher total. It is likely that many items will be found for which no vouchers exist, a list of these is made and if the officers cannot give a satisfactory explanation of any of them they are omitted. The total of what remains is added to the voucher total and represents the cash expended for the benefit of the original property, as shown by the books and vouchers.

8th.—Take all the remaining vouchers of the company (it is supposed that the examiner has already been informed by the officers, and by his inspection of the records, of the extensions and betterments which have been made), separate the vouchers for materials, labor, etc., from those on operating, etc. Next classify them by years, and then proceed as set forth in 7th, and add the different yearly amounts to the total of the original plant. This will show the amount of cash expended (according to the vouchers and books) on the property, for its physical plant, organization, etc., from its beginning to the date of appraisement.

Every examining engineer should know (or can obtain) the prices for materials, labor, etc., during these periods of original construction, extension, etc. If the prices are the same, or about the same, as at the time of purchase, the above total stands as the cash expended; if there should be much difference—and sometimes there is—take the detail of the materials as found in the vouchers, affix the proper prices, and do the same with labor, etc., and this total will be what, in the judgment of the examining engineer, the plant should have cost. A mean between this latter total and that in 8th is taken, in order to be fair and equitable. This amount, in place of that given by 8th, is then used as the cash expended on the physical property. If no difference is found in prices, then the total cash as shown by 8th is considered as the total to be hereafter used.

9th.—A careful detailed inventory is now made of the physical property as it exists at the date of examination. This often requires some excavation in order to determine sizes, quantities, and conditions. The prices used to ascertain the total of the inventory are made by taking the average of all those paid for materials, labor, etc., of the same class, during each year of the property's existence. (The writer considers it manifestly unfair to use the current prices in this calculation, for they may be very much below or above those actually paid, and in either event an injustice would be done, whereas, if the average prices are used, the examiner cannot be accused of unfairness.) To this total cost, as shown by the inventory, 5% is added for engineering and superintendence; 3% for general office salaries, 2% for general expenses, 1½% for legal and organization expenses, and from 5 to 10% for contingencies. (This latter percentage depends on the judgment of the examiner, who, after studying the local conditions carefully, can determine from his own experience what difficulties have been met in the construction. It is not believed that a hard-and-fast rule can, in equity, be laid down for this latter percentage.) This total represents the value of the tangible property, based on the inventory. The inventory cost and that set forth in 8th (or possibly as modified by prices current when the plant was built) are averaged, and this result, plus the supplies on hand, is the fair and equitable amount of cash which has been expended on the property. This is used in finding the "Fair and Equitable Value."

10th.—Next take the inventory of the plant set forth in 9th, affix the current prices at the date of appraisal, and to this total add the same percentages for engineering, etc., as set forth in 9th. This gives the cost of reproducing the property, with the same classes of materials, size and make of engines, etc., as is now in it, to which total add the cost of materials on hand for the total of cash required to be expended at current prices to reproduce the plant as it exists.

It is often found that this latter total is greater than that set forth in 8th, for the reason that the engines, etc., may be of types which are now abandoned or obsolete, and the manufacturing company, having to make patterns, etc., would charge more for them than the original price at the date of purchase.

This reproduction cost at current prices is only to give the examiner information he may or may not require later in the investigation to determine some point that might arise in ascertaining the "Fair and Equitable Value."

The writer considers it unfair to call the reproduction value the cost of a modern plant which will give the same service and output, because one is not dealing with the value of a modern plant, but with that of an existing property.

11th.—From this cost (using the detailed inventory to find the extent of property still in existence), calculate the amount of depreciation for each section of the plant, this being based on the present condition of the different parts and what their future life may be. The total depreciation is then deducted from the result found in 9th, and this remainder is used as the "Fair and Equitable Value" of the tangible property at the date of appraisal.

The intangible value (called by many names) must now be determined. It consists of rights, from the State, county, city, or any one or more combined, which the company must have in order to carry on its business. These rights in nearly all States are taxable, and taxes are collected on them. The Supreme Court of the United States has in the past held that they are property, notwithstanding what State "Courts and Commissions" have set forth on this subject, and in the writer's examinations they will be treated as property until the Supreme Court of the United States decides otherwise.

There are in general three classes of franchises, namely:

I.—Those granted by the State to conduct a business, where no county or city franchise is necessary, only requiring the company to obey the ordinances for excavation, etc. The charter of the Laclede Gas Company, of St. Louis, Mo., is an example of this class.

II.—Those granted by the State to carry on a business subject to a county or city franchise.

III.—Those granted by a city to an individual, singular or plural, or a company, to do business within its limits or a section thereof.

In each case the right may be a contract, for it may require a payment for the franchise granted, either in a lump sum or in yearly installments, or in the form of services rendered, such as for light, etc., free service of some kind, or a combination of any two or all of them.

The manner of determining the value of "Intangible Property" is as follows:

(_a_) The gross collected earnings are audited for each year during the period the company has carried on its business. The same is done for all vouchers, _i. e._, operating, maintenance, salaries, legal, general expenses, interest, insurance, and taxes, and includes every item disbursed. Whatever this latter amounts to, is deducted from each year's gross earnings as already found, and the result is the true net earnings or deficit for each year.