Overhead Charges.
There are certain expenses connected inseparably with the construction of any public work, which, on the completion of that work, are not capable of physical identification, but which, nevertheless, belong to and must be a part of the cost of the physical property. These expenses are legitimate; and, as long as the property is operated, a very large part, if not all, of the entire expense remains in the present value of the property as a "going concern."
Appraiser Cooley and his staff took up the discussion of these items and disposed of those which were carried into the valuation by the placing of a percentage. These items are:
Engineering.—This covered all the cost of preliminary and location surveys, design, and supervision of construction of the work, and all expenses connected therewith. This was covered by a charge of 4% of the cost of reproducing the permanent way and structure, but not the equipment.
Legal Expense.—This item is inseparable from the construction work, and was fixed at one-half of 1% of the cost of the same items as affected by the engineering charge.
Organization Expense.—This covered the cost of promotion, financing, and general supervision of construction, together with general office expense. These items were covered by an application of 1½% of the cost of the above items.
Interest.—This item is intended to cover interest on money during the period of construction. The length of time taken to build would, of course, be variable. It was assumed that 3% on the entire cost of construction and equipment would be conservative, and this figure was used.
Discount on Bonds.—This was not included, for the reason that it was considered, not as a proper capital charge, but rather as an adjustment of the interest rate to the existing market condition, and as chargeable to interest account and not capital.
The discussion among members of the staff indicated such a wide range of opinion as to the proper percentages to apply, that the final determination of the rates was passed upon by the Board of Review. There can be no question as to the propriety of these items as proper elements in the first cost of construction of a new railroad. On the theory that the cost of reproduction of the physical property should include every item of expense which would enter into the cost of reproducing the property as it existed on the date of the appraisal, they are proper terms to include in the appraisal. As to whether the fixed rates were high enough in every case, is an open question.
The Charge of Ten Per Cent. for Contingencies.—Perhaps no single feature of the Michigan appraisal of physical property has been so generally criticised as the charge of 10% of the entire estimated cost, including all the percentage charges, to cover "contingencies."
At the time the first appraisal was made, the writer was not at all satisfied that such an item, in such amount, should be included. The reasons advanced were so strong that it was done, and the writer's subsequent work has fully convinced him that it was proper and justifiable, because:
(a) The conditions under which this particular inventory and appraisal were made, as to time and lack of co-operation of the companies, made it practically certain that some items of value were missed in the appraisal, such as station and miscellaneous equipment, frogs, switches, track structures, buildings owned by the companies and occupied by others, etc.
(b) That there were many and large elements of physical cost not ascertainable by a physical inspection, such as deep foundations, many thousands of yards of earth in swamps and sink holes (a very general condition of roads in the Southern Peninsula), concealed classification due to growth of grass or washing of banks, and many other cases of work actually done, invisible after a lapse of years. The writer knows of many such instances on property which was in his charge many years ago; in several cases there were expenditures of from 0,000 to $50,000 which are now entirely invisible to an engineer passing over the line.
(c) The failure on the part of railroad companies to keep anything like a complete history of construction operations, and the changes of operating officials from year to year, cause the loss of record of practically all the expense due to extra hazard and risk which the construction engineer provides for by his "contingencies."
(d) The inclusion in operating expense, every year, of sums which are properly construction, and which, if added to unit prices of construction work, would cause the cry that such unit prices were too high. For instance, the appraisal estimate on earth was 17 cents per cu. yd., with no allowance for overhaul. Very much of the grade in the State had actual costs far in excess of this figure, and practically every road spends a large sum annually for the first four or five years, which is charged to operation but is in reality a part of the cost of completing the roadbed.
(e) No account was taken of appreciation of any of the elements entering into a road. There is no doubt that roadbed, for example, does appreciate, due to ballasting and track work. These items go far toward accounting for the contingencies item on an old road such as the Michigan Central.
(f) There is a considerable amount of cost, which cannot be taken out of capital, where facilities are abandoned or line or grade changed. These changes are common to all growing roads; they are due to the demands for greater traffic; they are necessary to the welfare of the community served; they are often made at points where no charge of defective design will apply. They might be termed expenses due to the development of the State, and, in the development of the railroad business, they were absolutely necessary for its present standard of efficiency. They are incapable of exact and definite determination, and must of necessity be included as contingent expenses.
In the case of a new road, where the exact cost is ascertainable, the records have been fully kept, the original plans are on file, and the history is fresh in the minds of the officials, it will be readily admitted that a charge for contingencies in large amount would not be justifiable; but, in the case of the Michigan Central Railroad, a line more than 50 years old, which has changed, rebuilt, and added largely to its property; in the case of the Pere Marquette Railroad, made up of the union of a dozen lesser properties, without any complete history; in the case of dozens of little lines, without maps, profiles, or records, some such allowance is fully justified and proper.
The experience of the writer, in the years that have passed since these appraisals, leads him to the opinion that the difficulty of estimating values on an old property are such that in many cases an appraiser might add, with perfect propriety, even more than 10% for the contingency item.
In computing overhead charges, no allowance was made for working capital, and no addition to the physical valuation was made to cover any such element as "going concern" value.