The limitations of the logical application of the methods suggested, however, are not sufficiently defined. Early in the paper an effort is made to avoid the necessity for this, and to simplify the treatment by limiting the scope of the paper, in the following language:
"This paper is confined to a discussion of the methods which should be used in arriving at a correct figure of cost of reproduction and depreciation—it does not take up questions involving the propriety of those figures when reached. The propriety or legality of using such figures as a basis for an assessed valuation, as a basis for rate-making, ... will be conceded no place in this paper."
Such a restriction, however, seems to the writer to leave the subject much confused. It is impossible to judge of the propriety or soundness of a method of valuation while ignoring its purpose and failing to point out the limitations of its logical application. To confine discussion to a consideration only of cost of duplication and depreciation of physical properties is presumably an attempt to avoid the difficulties incident to the application of such results to specific purposes, and is in line with the frequent argument of some attorneys in litigated valuations, that the engineer must not encroach on the province of the Court by having, much less expressing, any idea relative to the application of his figures to the final solution.
With this doctrine the writer has no sympathy. The engineer is essentially an economist, and no one is more fully qualified to aid, either directly or as an adviser to the Court, in the final determination of value for specific purposes, provided he is trained in the construction, operation, and valuation of such properties as are under consideration. To accept any less responsibility than this is to become party to inferior measures leading to popular misconception, and is justified only as a practicable first step toward the final realization and acceptance of the larger duty.
All suggested methods of valuation should be subjected to close logical analysis, with a view to their purpose. The unsuitability of the method used in the Michigan appraisal to many classes of appraisals is apparent, and can be readily indicated. Much space is given to justifying the appraisal of all so-called non-physical elements by the capitalization of the residue of net earnings after allowing interest on the investment in the physical properties. This the author refers to as Professor Adams' method. The addition of the physical to the non-physical values, as thus determined, is supposed to give the value of the property as a whole. It is evident that it gives, by indirection, the same total valuation as would be obtained by the direct capitalization of net earnings without any determination of physical values, per se, and, as a method, is therefore not what it purports to be. Since value, by this method, is in reality dependent on earnings, it follows that where rates are fixed by governmental authority, with the property value as the base, as is done annually in California in cases of privately owned water and lighting plants, the method suggested is without logical application, and the property values of such corporations must be determined and justified on other or modified grounds. Hence the necessity for dealing with such elements as so-called "going concern," franchise, and other possible assets, each independently, as is usually done in water-works appraisals, instead of collectively, as in the Michigan appraisal.
It should be made clear, therefore, that the method used in this railroad appraisal, for the determination of non-physical values, simply reduces the whole to one of capitalization of net earnings, and presupposes no governmental regulation of rates with the value of the property as the base; and, unmodified, has a comparatively narrow range of application.
The author seems to see difficulty ahead in dealing with rate-making by this method, for he says, near the close of his paper: "There are many intricate problems in connection with a valuation for rate-making or taxation which really belong to these undertakings, not to valuation," but, in stating some of these difficulties, he does not point out the impropriety of determining value by capitalizing that (earnings) which it may be the object of the valuation to determine and fix.
Regulation of rates by governmental authority, which means their limitation to that which is reasonable and just, will probably in the future be the purpose in the making of most valuations of the property of public service corporations, and no methods or rules for the making of appraisals can be considered as being at all complete or fairly comprehensive which do not meet the logic of such an end.
If capitalization of net earnings is to determine railroad values for rate-fixing, whatever the process, it must presuppose a fair and equitable rate, thus following the rate, instead of the rate following the property value. This is but a shifting of the difficulty; for, what constitutes a fair and just rate, irrespective of the value of the property used, is at least as difficult of determination as is the property value, irrespective of its earnings. Valuations, to be useful, must have their purposes carefully predetermined, that the right application of principles may be made.
Perhaps nowhere more than in California has thought been directed along this line, for the organic law of the State for thirty years has required the annual fixing of rates for water and light companies by public official bodies, and many important cases involving rates and valuations of large properties, chiefly in later years, have been tried. Unfortunately, the most important and best tried of these have not yet reached the United States Supreme Court. The result, thus far, is too long a story to be told now, but it may be said that capitalization of earnings in any form is not regarded as a logical basis of value under such conditions. Franchises, as they exist here, are not regarded as having value, unless from unusual circumstances. "Going concern" value is recognized, but its money measure is sought through other channels than present net earnings.