Review of Some Methods of Valuation, and Some of the Criticisms
on the Michigan Appraisal.
Much of the available literature on the subject of valuations is in the form of papers descriptive of water-works appraisals and arbitrations, many of which have been made, and a few of which have been the subject of valuable papers and discussions before learned societies.
Before the American Water-Works Association, D. W. Mead and J. W. Alvord, Members, Am. Soc. C. E., have presented papers[[12]] which have been quite fully discussed. The chief point of interest in these papers is the treatment of the intangible element termed "going value." Mr. Alvord advances the argument that, after the determination of physical present value, there should be added, to determine the fair value, two non-physical elements: the "going" or "business" value, and the franchise value. The first element is defined as that special value which is:
"Built up ... by the energy, perseverance and solicitation of the officers in charge, as distinct from the inert plant itself, ...
"The element of 'going value' has been before described as the element of growth in the plant irrespective of its physical condition. It is comparable somewhat to that indefinable quality known in other lines of business as 'Good Will'. Nevertheless it is something more than good will in water works business, as it represents what might be more aptly described as 'connected good will', that is to say, the acquisition of customers who have invested considerable sums in actually connecting their premises with the plant of the company, and provided appliances for the use of the water which it can deliver."
The method advocated by Mr. Alvord as the most rational one for computing this value is described as follows:
"It is assumed that a new plant will be constructed, the inception of which is coincident with the data of arbitration. Such new plant is to be of an equal capacity with the older plant under consideration, and a due allowance of time in which to construct this new plant, and the necessary capital to be invested in it from time to time is estimated. At the completion of this new imaginary plant, it is assumed that it commences to obtain business in that community from those who are not previously accustomed to the free use of public water, except in a general way; that it is to require the business ability and consequent increase in number of customers which the earlier and older plant went through within the early years of its existence. An assumption of the amount of business thus created for each year for a period of years in advance is carefully computed and estimated by the board of arbitration. The losses of interest upon capital invested are duly fixed, as well as the first absence and later addition of revenue from hydrant rentals, and a table is prepared showing each year, the total business developed and the total losses, if any. After this is completed a forecast is made of the business of the older works for the same period of time in the future that it takes the business of the new works to equal the business of the old works. If the business of the old works is found to be a growing one it will be a longer period that the new works will require to overtake it than will be the case if the business of the older works is stationary or decreasing. In general, the differences which might be called the debits and credits of this new imaginary plant and the debits and credits of the older working plant are reduced to their present worth at the time of appraisement, and an estimate is made up which will adequately represent the financial advantage which the old works (already fully equipped and in running order and having a large number of profitable customers) will have over the new works, where everything must be built and customers secured.
"It is necessary in making this supposititious estimate of the new plant to consider it in no way a competitor of the older works; there is not supposed to be competition between the new and the old, but it is left to the experience of the board of arbitration to consider how long it would take the new company to build new works, and build up business for the new works, until they have overtaken the business of the old company should it continue to occupy the same territory."
Mr. Alvord's description of his method has been quoted fully, as it is an interesting one and has been often used. It is open to the very decided objection that it is purely theoretical, a rational method of computation, perhaps, but based on assumption throughout. It may be said to be a method which is within the field of pure speculation. Mr. Alvord, himself, says that where experience in financial matters and the financial management of water-works is not brought into the valuation, there is usually to be found guesses of the wildest character. Professor Mead, in discussing Mr. Alvord's method and agreeing that it is consistent and logical, says: