The corporate history of the Ann Arbor Railroad, in Michigan, shows that it was built in sections of from 25 to 30 miles, and that each section was put into operation as soon as built, so that, while the actual period of construction of the complete property extended over 15 years, no section was under construction much more than one year. This is typical of much of the railroad building of the past, and on such a property the interest charge would be comparatively small.
A proper charge in such a case would clearly not be sufficient in the case of a road several hundred miles in length, through mountains, with tunnels, heavy bridges, and other structures which would extend the actual construction over periods of from 3 to 5 or 6 years, and this is particularly true where the road is a main line or artery, and where local traffic is of minor importance.
The computation of the interest charge is complicated by the fact that interest begins to run as the bonds are taken up, and but a small part of the construction money draws interest during the whole period.
The practice in the State appraisals has been to fix a uniform percentage for all properties. This has had in its favor the argument that it was conservative valuation where taxation is the ultimate end, as the amount was less than one year's interest in every case. It would appear to be more correct to use the corporate history of each company, determine the actual construction periods, and use a rate based on the actual time in each case. This can be fixed with a fair degree of accuracy, and a reasonable percentage determined, to equalize the varying periods of time on which the interest runs on different parts of construction.
Discount.—Discount on bonds is claimed by certain railroad men as a proper item for consideration. As has been argued elsewhere, this is not a proper charge against capital. It is an adjustment of the interest rate to the market, or an advance payment of interest; and, in the writer's opinion, should under no consideration be allowed.
Working Capital.—Working capital is another item claimed and conceded in some valuations. It is not a part of the "cost of construction." The money provided for working capital at the outset is not a permanent investment, but is rather a temporary loan paid back out of earnings. The writer fails to perceive any possible argument in favor of adding such an item to the permanent value of the property. In making an appraisal, after the physical value is determined, it is usual to set up a statement of stores, supplies, fuel, and cash on hand, and working capital is certainly shown by the current balance sheet, in the form of cash or accounts receivable. It would appear to have no place in a physical appraisal. Although the items of cash, stores, and supplies were shown in the Michigan appraisal, they did not appear as part of the physical value, nor were they taken into account in computing intangible value, but, being taxable property, they were reported separately.
(f) Contingencies.—The use of a percentage for contingencies in the appraisal in Michigan was bitterly contested by the railroads as improper and excessive. In Michigan 10% was used, in Wisconsin 5½%, and in Minnesota 5 per cent.
Subsequent work in Michigan has demonstrated that the use of as high a figure as 10% was fully justified; and the probability is that the latest Michigan appraisal did not eliminate omissions, inaccuracies of description, and excess cost of construction due to difficulties, to such an extent as to justify much reduction in the percentage.
In making an appraisal, the percentage to be applied to cover contingencies is a proper matter for consideration, and in some cases conditions might well be such that even a smaller allowance than that fixed in Minnesota would be proper, but such cases would doubtless be the exception. The writer believes it to be proper practice to add liberally for the contingency item. The strongest argument against it is that it is incapable of being described and located definitely, and is difficult of exact proof. Therefore it has been claimed that it partakes of the nature of a non-physical element, and that if there be any value over and above the physical property value, it will appear with other non-physical elements reflected in the earnings, and may be properly included in the intangible value if such exists. This argument does not appeal to the writer as being final, and he would advocate the use of such a percentage of physical values as appears proper in each appraisal to cover the error due to the extreme difficulty of securing an exact inventory and construction history of the properties.
(g) Design.—Among the matters which were considered in the Michigan work was that of adaptability, or the economical questions of location, design, and construction. It is possible that in some properties, such as water, gas or electric companies, the efficiency of the plant may be very greatly affected by faulty design, uneconomical arrangement, improper construction, and to such an extent that any cost of reproduction, less any ordinary depreciation, would be greatly in error without further allowance. This may also be true of railroads. Excessive curvature and gradients greatly decrease the tonnage hauled by a given power, without decreasing the cost per train-mile.