Physical Values and Methods for Their Determination.
All the foregoing narrative of methods adopted in recent valuations, review of judicial opinions, and comment on the expressed opinions of various engineers and railway officials, is presented as being proper and necessary to support the contention that the Michigan valuation, while not the first appraisal work, was the first valuation work of large magnitude undertaken by any State; that it was a work which established many precedents; and that the complete discussion of methods and principles in connection with and following this appraisal has given it probably a greater general value than any similar undertaking. The Wisconsin work, which immediately followed that of Michigan, was along lines similar to those of the Michigan physical valuation, and carried the work forward, adding to and strengthening certain of its features. Without any impropriety, it may be claimed that these two appraisals have laid down the general lines on which this class of engineering effort will be largely directed in the future.
It is desirable, in closing this paper, to indicate such general methods of procedure in valuation practice as may be said to have been thoroughly established by precedent, and to present such argument as will support the contention that such methods are proper.
The fact has been emphasized, again and again, by every writer on the subject, that problems of this class are not capable of exact mathematical solution; that, no matter how much care may be exercised in the execution of the work, the result is tempered by the personal judgment of the men engaged on it, and that only when it is executed by men of experience, sound judgment, and high moral worth can it have a definite, final, and just result.
This feature of appraisal work cannot be too strongly emphasized. The value of the work depends on the character of the men doing it, their experience in design, construction, and operation of properties, and their absolute fairness and freedom from prejudice.
That there will be many large valuations undertaken in the near future, there appears to be no doubt. These valuations will be made as a necessary preliminary to three classes of corporate control: rate-making, taxation, and the regulation of capitalization.
The Courts hold that the value must be "the fair value of the property used for the public," and that the corporation:
"may not impose upon the public the burden of such increased rates as may be required for the purpose of realizing profits upon [such] excessive valuation or fictitious capitalization." (Smyth vs. Ames.)
This language is repeated, again and again, so that it is clear that any valuation, to be sustained by the Courts, should:
1.—Be based on a careful study and analysis of all the information applicable to the case in hand; and
2.—That it must separate the various elements so that every step of the work may be reviewed and supported.
Public interest demands that, in any valuation, certain figures shall appear which shall show the amount of bona fide capital actually existing in the property at the date of appraisal.
The fact that a given amount of money was invested in building a railroad in 1880, and that certain other sums were spent for additions in subsequent years, does not necessarily indicate that these amounts of capital will still be found in the property in 1910.
The removal of timber from surrounding lands, the destruction of industries and the removal of tracks leading thereto, the destruction of equipment and facilities, the depreciation in value of adjacent property, along with wear and tear, and obsolescence, have gone to effect the destruction or loss of capital on many Michigan railroads. The case in 212 U. S., 1, clearly directs that the valuation must not take into account this destroyed capital, but must return a "fair value of the property as it is."
On the other hand, the amount of money actually spent in producing a given property in the past may be far below the present value. The appreciation of value of lands by reason of development of cities and growth of industries, the increase in cost of the materials entering its construction, and many other causes, may lead to an appreciation of the value of the property, and this appreciation should appear in the valuation and the company be entitled to the benefit of it. It is in the nature of an increase of the investment, and should appear as capital.
It is clear that there are two classes of elements of value in the final value of a public service property: those which are physical, and those which are intangible. There are various of the physical elements of value which are not material or susceptible of inventory, but which, nevertheless, attach themselves to the physical property, are capable of determination, within reasonable limits of certainty, and should be taken into account and computed as physical property.
In the subsequent discussion of physical and intangible values, it is attempted to differentiate between such elements as should attach to the physical value, or capital remaining in the plant, and the purely intangible or franchise values.
It is contended by the writer:
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.
It is further contended that, in making the physical appraisal, the purpose of the appraisal should not be permitted to modify the figures. The resultant figure should be the same, whether it is to be used as a basis for assessment, rate-making, or limitation of capitalization. It should be an engineering estimate of the amount of bona fide capital still remaining in the property, or of the complete cost of reproduction under existing conditions, less depreciation. This figure is definite, within reasonable limits, and it cannot be conceded that it is permissible to vary it, submitting one result as a physical value for taxation, and another and different result as a present physical valuation for rate-making.
There may be some question as to the propriety of using non-physical values for certain ultimate ends; in fact, the Supreme Court, in the Omaha and Knoxville water cases, clearly indicates that they must not be used for certain purposes; but, in any case, to furnish information, this element of value should be determined, and, as in the case of physical values, it should be an unchangeable figure[[18]] and should represent the difference between the worth of the actual physical property and the final business value of the property considered as an earning proposition.
It is not necessary to go minutely into detail as to the various steps to be taken in making the appraisal of physical property. Each appraisal will offer some problems peculiar to itself, and no general set of rules can be laid down which will be applicable to all cases. It is deemed sufficient to call attention to general matters of major importance and to refer to some points which have not been mentioned in the preceding narrative, omitting argument in the case of such as have there been fully discussed.
The distinction should be kept in mind that any element of value which belongs to the property by reason of its physical existence is classed as an element of physical value. The property is considered as an operating property in the sense that it is reproduced complete, ready to operate; and any expense, or any element of value needed to complete it, is an element of the physical value, but any value arising as a result of surplus earning power, any good-will value, going-concern value, or value due to established business, strategic location, favorable traffic arrangements, etc., should be considered as intangible values.
The valuation of physical property is naturally divided into four parts:
I. —The preliminary study, II. —The field inspection, III. —The computation, IV. —The preparation of the final figure.