12th.—The amount given by 11th is added to the result obtained by 9th, and this total is the "Tangible and Intangible Value" of the property, and the "Fair and Equitable Value" of the property at date of appraisement.
If it is found that grave mistakes in design or judgment have been made by not employing competent people, and money has been wasted in construction, the plant is re-designed, for the original plant, and its cost estimated. The same is done for each extension, using the prices paid at the different periods, and this result is used in place of 9th, as the cash cost at the date of appraisement.
In determining the intangible value, if it is found that the management has been careless in order to make large net earnings, at the expense of the physical property, estimates are made of what the property can be operated and cared for (here the practical knowledge of operation, etc., is necessary), and these results, plus taxes, etc., are subtracted from each year's collected earnings. The mean or average of these results is considered as the true net earnings, which are capitalized and added as set forth in 12th.
The writer holds that consumers or purchasers should not pay for avoidable error or ignorance, and the amount of the securities issued on the property is not considered as entering into the matter of "Fair and Equitable Value"; when they do, the method is somewhat different.
The mean true net earnings are used in determining the intangible value, because franchises have average values, as earnings and expenses fluctuate in corporations, and, when intangible values are to be considered, they must not be based on the last year's net earnings, for if they are, they may give a very large result in one year and a small one in the next; therefore, to be fair, the mean true net earnings should be the basis of the intangible value. If the company has been over-capitalized, and no sinking fund or depreciation has been set aside, it is the present owner's misfortune. If the company calls something a betterment, and it is found that the betterment has only replaced something, it is not allowed, but is classed as maintenance; on the other hand, if the replacement is larger, and capable of rendering greater results, such as a larger engine, pipe, cable, etc., the cost, less the cost of what it replaces, is allowed as a betterment, and if the old part is sold the proceeds are deducted from the betterment charge, for if it is credited to maintenance, it increases the true net earnings. This is often done, but is not the correct way to treat the matter, for it increases the intangible value.
13th.—When new rates are to be established for a period of future years, the manner of determining the "Fair and Equitable Value" is the same as has been heretofore set forth. The new rates are based on averages, and the first step necessary is to ascertain what gross revenue the company must have in order to pay all classes of operating expenses, maintenance, depreciation, taxes, interest on the "Fair and Equitable Value" of the property, and a reasonable profit.
To obtain this amount, the procedure is as follows:
(a) Find the percentage of increase of the operating expenses for each year over the prior one, for a period of generally five years preceding the date of examination (a longer time may be taken if, in the opinion of the examiner, it is necessary), and then ascertain the average annual increase of the percentages. The result thus obtained is taken as the increase percentage for the operating expenses for the new period of time.
(b) In order to determine what the operating expenses will average during the time the new contract is to run, take the amount of the last year's operating expenses as a basis and add to it the percentage found by (a). This total is the operating cost for the first year of the new contract. The amount for the second year is found by adding to the cost of the first year the percentage found by (a), and so on for each year of the new period. These results are added together and their average is then used as the mean cost of operation for each year during the full period.
(c) The same method is followed for maintenance and taxes, in order to find the average maintenance and taxes for the new contract's life.