Explanation of Terms.
In order that there may be no doubt as to the exact meaning of the terms used throughout this paper, a few definitions or explanations are submitted:
Appraisal, or Valuation.—These words are used interchangeably, and refer to the engineering work of determining the present worth of both physical and intangible properties of corporations.
Cost of Reproduction.—This expression refers to the estimate of cost of reproducing the physical properties as they exist on the date of the appraisal, all elements entering into the cost being considered as new and not affected by the elements of depreciation or obsolescence.
Cost, or Original Cost.—These terms refer to the actual amount of money paid for the property, either when it was originally constructed, or in its condition at the time of appraisal, the latter case being the original cost plus the cost of additions and betterments, less abandoned, replaced, or worn-out property. This figure ought to be represented by the "book cost," but it is not often that "book cost" and "actual cost" are the same.
Present Value, or Present Physical Value.[3]—These terms are used in describing the physical property as reproduced after it is affected by all elements of depreciation or appreciation. The use of the word "value" in this expression is unfortunate, as it may lead to some confusion. It must be kept clearly in mind that, where this term is used, it refers only to physical property as depreciated, and is in no case intended to refer to the final or "fair value" of the property.
Non-physical, or Intangible, Value.—These terms are used to represent those elements, entering into the final worth of the property as a business concern, which arise out of the operation of the property and are not attachable to the physical property.
All the foregoing terms have to do with the determination of the elements which enter into the final value.
What is "value"? In defining the exact meaning of this term, as applied to the property of a public service corporation, many elements must be taken into account. Standard authorities give many definitions of "value," none of which appears to meet fully the requirements of the term as used herein. Before considering the elements which enter into the value of corporation property, or attempting to determine the methods to be used in fixing proper figures of worth for each of these elements, it is proper and necessary to obtain a clear definition of "value," the thing sought to be ascertained by the inquiry.
The term, "commercial value," has been considered in place of "value," but is not used because it is held to be more properly applicable to the selling or exchanging value of fractional interests in the property, and the methods of computing the commercial value of securities which are in common use cannot be adopted in an engineering valuation. The Standard Dictionary definition of "commercial value" is:
"The source of commercial value, according to different schools of economists, is (1) the degree of want felt for a commodity as shown in the relation of supply and demand, (2) the amount of labor embodied in it, or (3) the cost of reproduction. Practically, commercial value is that for which a thing can be sold or exchanged at a given time and place."
The definition given by Professor Adams is:
"The estimate placed upon the worth of a property, regarded as a business proposition."
Both these definitions are in a measure involved, and the writer considers that the term, "Commercial Value," is too narrow and restricted to be properly used.
As a definition of that estimate of worth which an engineering commission should report as the result of a complete appraisal, the writer submits the following:
The value of a property is its estimated worth at a given time, measured in money, taking into account all the elements which addto its usefulness or desirability as a business or profit-earning proposition.
There are two classes of elements entering into the final value:
(1) The "Physical Property" Element of Value.—This consists of those things which are visible and tangible, capable of being inventoried, their cost of reproduction determined, their depreciation measured, and without which the property would be unable to produce the commodity on the sale of which income depends. This physical property is considered as an operating entity, and not as collateral of inert and partly worn-out equipment, and, being so considered, carries, as part of the physical value, those costs and charges which are an inseparable part of the cost of construction but do not appear in the inventory of the completed property.
(2) The "Non-Physical" or "Intangible" Elements of Value.—These are those things which, added to or taken from the worth of the physical property, make up the value, and include whatever accrues to the property by reason of its operation, or by reason of grants, contract rights, competition, or location, which at the time of appraisal affect favorably or unfavorably the worth of the property.
The worth of the physical property is primarily that on which the value of the whole property rests.
While it is clear that the worth of the physical property, being the cost of reproduction less depreciation, is not necessarily the value of the property, it is equally clear that the physical worth must bear some very definite relation to value, and the writer is strongly of the conviction that this relation is such that "value" cannot be ascertained without a determination of physical worth. The physical property element represents the investment on which a fair return is to be earned, and in most cases an appraisal is necessary for the determination of the amount of money actually invested. As illustration of the fact that "physical value" and "value" are not the same, the case of two railroads actually existing and in operation between two cities in Michigan may be cited.
Road "A" occupies a narrow valley through high and abrupt hills. Its alignment is fair for hilly country; its maximum grade is 1 per cent. It has a number of bridges, all short and low. Its cost of reproduction might reasonably be placed at $28,000 per mile. A mining town at one end ships a heavy tonnage down grade to a lake port at the other.
Road "B" was constructed several years later, and, being barred from the only valley, built a line across the hills, involving heavy grading, very long and high steel trestles, a longer line, maximum grades of 2%, and a heavy climb from the mining town to the summit before starting to drop to the lake. The cost of construction was more than double that of Line "A," and the tonnage which can be hauled in either direction is but a small fraction of that which can be hauled with the same power by Road "A." A reasonable figure for cost of reproduction may be given as $60,000 per mile.[4]
Here is clearly a case where the older, less expensively built road has a value as an earning proposition far in excess of that of the new road. The rate on commodities does not affect the relative difference. A higher rate, while permitting Road "B" to live, greatly adds to the value of Road "A," while the latter can operate at a profit on rates which would not permit Road "B" to pay expenses.
This example indicates the existence of non-physical values, not only positive in the case of Road "A," but also negative as to Road "B."
Many properties have been built in the United States, representing large investments of capital, which are not, and some of which can never be, profitable business investments. In all such the physical valuation will exceed the final value where the property is considered as an operating concern, and a negative factor to cover improper location, uneconomical design, ill-advised investment, or whatever the trouble may be, should be applied.
The physical property is that which enables the corporation to do business. Without physical property it could not produce the commodity which it sells. The amount of money actually invested in acquiring that physical property represents the measure of capital on which it is morally entitled to earn interest and profit; and, in the stage of promoting and financing the enterprise, all hope of earnings is based on the amount of money required to construct the property. These considerations lead the writer to contend that the true method of valuing a corporate property is first to determine the cost of reproduction of the property and its depreciation, and modify this figure by any applicable positive or negative non-physical elements of value.
3.The term "present value," as used in this paper, should not be confounded with its use by bankers or accountants, or with the present worth of a sum of money due at some future time.
3.The term "present value," as used in this paper, should not be confounded with its use by bankers or accountants, or with the present worth of a sum of money due at some future time.
4.In this case, traffic as to Line "B" is limited, and as it is feasible to double-track Line "A" at less cost than Line "B," no advantage can be assigned to Line "B" on account of development of future business.
4.In this case, traffic as to Line "B" is limited, and as it is feasible to double-track Line "A" at less cost than Line "B," no advantage can be assigned to Line "B" on account of development of future business.