101 1 8^5 CORNELL UNIVERSITY LIBRARY asQNia xiiHdwvd BUREAU OF RAILWAI ECONOMICS Established by Railways of the United Stales fejji ,, for the Scieotrfic Study of Transportation Problems wt^if'" LOGAN G. MePHERSON DIRECTOR FRANK HAIGH OlXON CHIEr STATISTICIAN A Comparative Statement of Phyaacal Valuatidn and Capitalizatioii olin Serial 'f§^*t. 4 , Cornell University Library The original of tiiis book is in tine Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/cletails/cu31924030120335 A Comparative Statement of Physical Valuation and Capitalization Serial No. 4 WASHINGTON, D. C. 1 Q t 1 10-7; I OHZ^-rz PHYSICAL VALUATION AND CAPITALIZATION. INTRODUCTION. An attempt has been made in this study to compare as accurately as possible the physical value and the capitalization of steam rail- ways in the states in which official valuations have been made, that is, in the states of Washington, South Dakota, Michigan, Minnesota and Wisconsin. The state of Texas is considered only casually for reasons which appear in the discussion. It should be noted that in every case the statistics pertaining to value cover only physical properties. No attempt has been made to secure intangible valne, which, as a matter of fact, has been arrived at only in one or two instances by State Commissions. The omission of intangible value should be held in mind in comparing physical value and capitaliza tion, for it is at least an open question whether intangible value may not properly be capitalized. The most significant question involved in the method of physical valuation is the manner in which right-of-way and terminal value is obtained; in other words, whether or not the railway is to be allowed a value for its land gTeater than that of adjoining land, because the railway corporation must settle all damages created by its entry upon private property, and because it frequently must pay an enhanced price for the land which it purchases due to the knowl- edge on the part of the landowner that the railway must have it at any price. The methods of valuing such land, so far as they could be discovered, are given in the text. It will be observed that Wash ington. South Dakota, Michigan and Wisconsin make allowance for this added cost in estimating cost of reproduction, and that the Minnesota Railroad Commission while disapproving the jnethod in principle, has nevertheless had a valuation prepared upon this basis. In this connection, it should be noted that the valuations of both Michigan and Wisconsin were made for taxation purposes. Assignment of capitalization to the different states has been made upon the single track mileage, that is, upon the road mileage basis. While this is not the most scientific basis, it is the only practicable one which could be employed, for statistics are in most cases not available for an assignment upon any other plan. With a few notable exceptions, the commissions of the different states present only incomplete and undigested statistical matter in their annual reports. It is necessary to call attention at this point to a matter of tech- nical detail which becomes, in its application, of very considerable importance. Some of those who have already published comparative statements of value and capitalization have made assignments of capitalization to states upon an erroneous basis. It has apparently been the practice to find the ratio of the aggregate mileage within the state to the total mileage of all the systems traversing the state, and then apply this percentage to their total capitalization to determine the state's proportion of capitalization. This method is simple, but it leads to erroneous results, because it applies to a series of different capitalizations an average percentage, which, as a matter of fact, is applicable to no one of them. The only correct method is to determine the capitalization of each road separately on the mileage pro-rate basis, and then add the results together to obtain the aggregate of state capitalization. This latter method has been followed in this presentation. So many errors have been discovered in the statistical tables prepared by the State Commissions that these reports have not been relied upon in most cases for total mileage or total capitalization. The Statistics of Railways of the Interstate Commerce Commission has been generally used. In attempting this comparison of physical value and capitaliza- tion, many difficulties have arisen which could not be entirely removed. 1. In the first place, when the valuation has been made by a body other than the railroad commission, it has been difficult to identify in every case the corporation whose property was valued, and to assign to such corporation its proper capitalization. Roads report- ing their capitalization to the Commission are as a rule the operating roads, while the roads are valued under their corporate names whether operating or not. Adjustments have in some cases been necessary, but these adjustments have in no case affected the conclusions drawn. 2. As a result of the intercorporate relationships of the various railways, the aggregate capitalization, even within the limits of a single state, contains more or less duplication. This duplication it has been the purpose of this study to eliminate as far as possible. The most striking case which has been encountered is in Minnesota, where not only is the capitalization of the Chicago, Burlington & Quincy included, but at the same time there is, embodied the Great Northern's share of the $215,000,000 bond issue with which the C. B. & Q. stock was purchased. Moreover, in eliminating such duplications, this study has followed the practice of the Statistician of the Interstate Commerce Commission, who eliminates collateral trust bonds before computing funded debt per mile for the individual railway corporations. All collateral trust bonds have been elimi- nated from the aggregate capitalization of the individual road before its stock and bonds have been assigned to the various states. In the same manner, bonds of proprietary companies have been deducted when these proprietary companies appear separately with their own capitalization. A third form of duplication has been corrected by deducting securities held in the treasury. It is evident that securities for which no value has yet been received cannot properly be included in a study which compares capitalization and physical value. Again, securities held in sinking funds have been eliminated from total capitalization. Appropriations to the sinking fund are merely appropriations for the retirement of debt, and the statement that securities are "kept alive" in a sinking fund is largely a fiction. Finally the total capitalization is increased beyond its proper size for comparison with physical value by the fact that it is frequently issued to cover "other properties" than railways. Railways are frequently engaged in business other than transportation and no distinction is made between securities issued for transportation and those issued for miscellaneous purposes. So far as it has been possible, capital issues covering "other properties" have been elimi- nated, but to do this adequately would have required a more extended investigation than was possible at this time. Hence, it is probable that a considerable amount of capitalization is included in the comparative tables which might properly be eliminated because it does not represent railway property. Even with all these deductions there are doubtless other duplications which might be eliminated were a careful study made of the purpose for which capital stock was issued by the various roads, yet it must be clear from the eliminations which have been made that the object is to set up against physical value the securities outstanding in the hands of the public upon which corporations are entitled to earn. 3. It is evident that an allocation of capitalization upon a mileage pro-rate basis is not an accurate figure for a comparative study of this character. It does more than justice to some states and less than justice to others. A state like South Dakota with most of its mileage single track and with no valuable terminals gets on a mileage pro-rate far more than its proportion of the capitalization of the roads which operate within its borders, for there is credited to the state a portion of the capitalization which belongs to valuable properties located elsewhere. On the other hand it is possible that the capitalization of the Washington railways should be increased beyond the amount allotted on a mileage pro-rate if correct results are to be obtained. An illustration of the inaccuracy of this method is found in Wisconsin where the Illinois Central with nothing but branch line mileage in the state and no valuable terminals has its capitalization assigned to the state on a road mile basis. This difficulty is inherent in the situation. It only serves to make clear the proposition that if railways are to be valued at all they should be valued as units and not piecemeal by the separate states. From what has just been said it must be clear that such a com- parison as is presented in this study cannot be conclusive. It has been made in the hope that some degree of accuracy might be reached in a subject which has received of late much inaccurate treatment. WASHINGTON. The source of information for tlie valuation of Washington rail- ways is the "Findings of Fact" of the Railroad Commission of Washington published in 1909. The results of these iindings were embodied by Mr. J. C. Lawrence of the Washington Commission, in an article in the Railway Age Gazette of February 18, 1910, from which the facts here given were derived. Commissioner Lawrence in this article discusses the methods employed in the valuation of Washington railways, and it will be of interest to quote from his discussion before presenting the statistical results : The cost of reproducing right-of-way and terminals was estimated on the basis of market value of adjacent property, plus the additional amount experience has shown a railway company must pay for consequential damages in securing such property. * * * The unearned increment was allowed in the cost of reproduction. This may be either in the cost of construction of roadbed, structures and equipment or in the right-of-way and terminals. To fail to allow such increased value would be as unfair to the public as to the railways. Take for instance the terminals of an established road in an important city which were acquired at a low value, say for a million dollars; a new line is constructed and, to acquire its terminals contiguous to and of equal value to that of the estab- lished road, pays, say $10,000,000. If the latter road were not allowed the value it paid then it would be deprived of a return on the amount actually and necessarily invested in acquiring its property, and in that way deprived of the property itself, for the value of the use of the property is in reality the property itself. If this value were allowed to the latter road and denied to the former, then traffic tributary to the one would have an' advantage over the other, and the construction of additional and competing roads would be discouraged. * * * The Commission concluded that on an established road, maintained to a proper standard of efficiency, there would be no continuing depreciation; that on a newly constructed line there would be a rapid depreciation of certain elements during th4 first few years. This would apply particularly to ties, and, in a lesser degree, to wooden structures and equipment. On the other hand, there would be an appreciation of roadbed on a new line, due to the seasoning and hardening which follows its use, attributable not only to set- tUng of embankments, thus rendering the condition of the roadbed more permanent and safe, but to the necessary labor involved in raising and widening embankments, cleaning out and widening cuts, safeguarding them from slides and remedying the defects occurring in construction and the contingencies which necessarily follow. Such appreciated value of roadbed would largely affect the depreciation in the value of the other items. The appreciated value of the roadbed was added to the estimated cost of reproduction new, and from this sum deductions were made to cover the depreciation of all other items. * * * JBut the depreciated value of a road In profitable operation does not equal its market value. To this depre- ciated value must be added a sufficient amount to cover the enhanced value due to building up a successful transportation business. It is Inconceivable that the value of such a business enterprise under efficient management should depreciate from a market standpoint. In his discussion of "market value" Mr. Lawrence considers such influences as prices of outstanding securities, density of population, amount, permanency and class of traflSc, and value of facilities for doing business. In view of the fact that the Washington Commission has not made any statistical summary of its findings, it ha.? been somewhat difficult to determine whether the entire mileage of the state was valued and what was the length of mileage actually included. In a personal letter under date of December 18. 1910, Commissioner Lawrence writes that the valuation included in their "Findings of Fact" of 1909, covers "the railway mileage in existence at the time of the creation of the Commission, June, 1905, approximating 3,300 miles. Since that date the mileage has been increased to a little in excess of 5,000 miles and the Commission is now engaged in valuing this new construction." Yet from the tabular summary presented in the article referred to, the Commissioner seems to account for only 3,016 miles, and this figure has been used in presenting the per mile of line valuations in the table below. In view of the fact that the valuation included only the mileage in existence in 1905, it has been necessary to use the 1905 capitalization as a comparative figure. It has not been found possible to present statistics of capitalization for the exact mileage involved in the physical valuation, but the figure employed, 3,167 miles, is so nearly identical that the worth of the comparison is not destroyed. Washington — Physical Valuation and Capitalization. Physical value (1905-08): Total. Mileage. Per mile, Cost of reproduction new $194,057,240 3,016 ?64,343 Present value 175,797,025 3,016 58,288 Market value 195,662,635 3,016 64,875 Capitalization 168,696,670 3,167 53,267 8 SOUTH DAKOTA. At the time that this study was made, the report on physical valuation for the state of South Dakota had been completed but had not yet been published. Such information as is here given was obtained by correspondence. In valuing railway lands the Commission used the multiple of 250 per cent as an average, and applied it to all farm and city lands traversed by the roads ; that is, it estimated railway land to be worth two and one half times that of adjoining land. The number of miles valued was 3^953. Although the Commission dated its valuation June 30, 1909, it appears that the valuation was begun under an act of 1907, and that much of it had been completed before January 1, 1909. A more accurate comparison of actual conditions would probably have been made had capitalization figures been used for 1908 instead of 1909. However, the 1908 figures have been employed in the case of but one road, the Chicago, Milwaukee & St. Paul of South Dakota, and this was because its intercorporate relationships with the parent company were not fully adjusted on June 30, 1909. South Dakota — Physical Valuation and Capitalization. Physical value 1908: Total. Mileage. Per mile. Cost of reproduction new $106,494,503 3,954 $26,933 Present value 91,695,132 3,954 23,190 Capitalization 138,850,297 3,954 35,116 MICHIGAN. The original appraisal of the physical properties of Michigan rail- ways was conducted in 1900-01, under the direction of the Board of State Tax Commissioners. Since that time the Tax Board has annually presented a table of assessed value of railway property, which by law must be an assessment at what the Board considers the actual value of the property, that is, a 100 per cent assessment. The assessed value is doubtless intended to correspond with "present value" as determined by the original valuation. Yet the Tax Board in its annual presentation of assessed value omits figures of cost of reproduction new, gives no table of mileage valued but merely the name of each corporation, and gives no indication that a genuine investigation of railway values has been made. This leads to the inference that no valuation of railway property has been attempted lu the state of Michigan since the original valuation by Professors Cooley and Adams. It has seemed best, therefore, to include a comparative statement of valuation and capitalization for the year 1900, as well as the incomplete statement for 1907. In cases where capitalization could not be found for corporations listed in the report of the Tax Commissioners, the assessed value of such corpora- tions has been deducted from the total in order that the statement presented might be properly comparative. The method of valuing right of way and terminal lands is described as follows by Professor Cooley in his report to the Michi- gan Board of State Tax Commissioners: The question whether the increased cost of right of way over and above the value as determined by contiguous property may properly be Included in the present value of a railroad, is a matter about which there may be a difference of opinion. The true cash value of a thing has been defined aa the price upon which a purchaser and a seller mutually agree, and at which an actual transfer takes place. If an attempt were made to purchase an existing right of way, as, for example, an entrance into a city, if the owner were billing to sell at all he surely wduld take Into consideration what it would cost the purchaser to get into the city by any other route, and the prospective purchaser would surely consider what it would cost him by another route. The conclusion finally reached was to add to the value of the right of way, as determined by contiguous property, an amount fairly repre- senting the additional actual cost to the railroad. Michigan — Physical Valuation and Capitalization. Physical value 1900: Total. Mileage. Per mile. Cost of reproduction new $202,716,262 7,813 $25,946 Present value 166,398,156 7,813 21,298 Capitalization 291,605,232 7,813 37,323 Physical value 1907: Present value 204,033,500 8,343 24,456 Capitalization 357,555,907 , 8,343 42,857 MINNESOTA. The state of Minnesota has recently completed a most exhaustive physical valuation of railways as of June 30, 1907. This report requires little comment as the very complete statistical presentation explains itself. As already noted, the valuation was made on two different bases, described below as Estimate A and Estimate B. In Estimate A, allowance is made for the price which railways would have to pay for the land for railway purposes, including damages and monopoly prices for land. In Estimate B, land is valued on the same basis as land lying in contiguous territory. The Minnesota Commission contended for the valuation represented by Estimate B, the railways maintained that Estimate A was the fairer one. In this connection, reference should be made to the basis employed by the states of Washington, South Dakota, Wisconsin and Michigan. The capitalization figures are those for June 30, 1907. The 10 considerable reduction in the capitalization figure below that com- monly quoted for Minnesota is due to the elimination from the Great Northern's capitalization of |107,000,000, being its proportion of the Chicago, Burlington & Quincj collateral i's issued jointly by the Great Northern and Northern Pacific. In view of the fact that the Chicago, Burlington & Quincy capitalization is already included in the total capitalization of Minnesota railways, it is an obvious duplication to include in the capitalization of the purchasing com- pany any part of the bonds with which the Burlington stock was purchased. *Minn€sota — Physical Valuation and Capitalisation. Physical value, 1907, Estimate A: Cost of production new — Total. Mileage. Per mile. Carrying roads 1397,299,471 7,577.71 $52,430 Switching roads 14,435,724 18.72 770,933 Total 411,735,195 7,596.43 54,201 Present value: Carrying roads 347,051,336 7,577.71 45,799 Switching roads.... 13,428,824 18.72 717,160 Total 360,480,160 7,596.43 47,454 Physical value. Estimate Bl: Cost of reproduction new 373,820,141 7,596.43 49,210 Present value 322,565,107 7,596.43 42,463 Physical value, Estimate B2: Cost of reproduction new — . Carrying roads 350,106,321 7,577.71 46,202 Switching roads 10,855,227 18.72 579,718 '^"tal 360,961,548 7,596.43 47,517 Present value: Carrying roads 299,858,186 7,577.71 39,571 Switching roads 9,848,327 18.72 525!945 ■^"^^^ 309,706,513 7,596.43 40,770 Capitalization: Carrying roads 292,299,292 7,577 71 38 574 Switching roads 7,728,404 18.72 412',732 '^°^^ $300,027,696 7,596.43 $39,496 •Estimate A includes multiples on lands for right of way, yards and term- inals, and allowance for adaptation and solidification of roadbed Estimate Bl omits from Estimate A multiples on lands for right of way yards and terminals. Estimate B2 omits from Estimate A multiples on lands for right of way, yards and terminals, and allowance for adaptation and solidification of roadied. 11 WISCONSIN. The appraisal of the physical properties of Wisconsin railways is in charge of the Wisconsin Tax Commission, and is made primarily for taxation purposes. The original appraisal was made as of June 30, 1903, and annual revisions thereof have been made through the medium of reports by the railways to the Engineer of the Commis- sion. The last report just received is dated June 30, 1909. Concerning the method of valuing right of way and terminals, Professor W. D. Taylor, then Engineer of the Commission, made the following statement in a report to the Commission dated January 2, 1905: To determine the value of the land in the present right of way, such lands must be deemed as belonging to the owners of the adjoining lands and to be acquired by negotiations with such owners or under the power of eminent domain, whereby the owners are entitled to just compensation for the land actually taken and for depreciation in the market value of the residue in consequence of the railroad crossing the part taken. In ordinary language, the inquiry will be first, what is the fair average market price per acre for ordinary purposes of the land taken, and second, how much is the depreciation in the salable value of the residue of the parcel, lot, or tract with the buildings thereon from which the right of way is severed. The sum of the two items, first, the market price of the land taken, and the second item, depreciation in the salable market value of the residue, will constitute the right-of-way value. The figures of total capitalization are those reported by the rail- ways to the Wisconsin Railroad Commission on June 30, 1909. The Tax Commission has valued a number of private unincorporated roads, which have no capitalization. The valuations of these roads have been omitted from the table presented herewith in order to make the comparison more accurate. The mileage figure used in computing capitalization per mile could not be made to agree exactly with the mileage valued but the discrepancy of 39 miles is not sufficient to disturb the general conclusions. Wisconsin — Physical Valuation and Capitalization. Physical value 1909: Total. Mileage. Per mile. Cost of reproduction new 1296,803,322 7,098.70 $41,811 Present value 240,718,711 7,098.70 33,910 Capitalization 311,819,128 7,060.00 44,167 TEXAS. The Texas Railroad Commission estimates the total value of railroads in that state up to October 31, 1909, at $212,794,586 or 117,198 per mile of line. The aggregate capitalization on June 30, 12 1909, including equipment trust obligations and current liabilities, is given as |420j031,677, or |31,910 per mile of line. These two totals have often been compared and conclusions have been drawn from them unfavorable to the methods of railway capitalization. Yet a moment's consideration will show that the two totals have no relation to each other whatever. By the Stock and Bond Law of April 8, 1893, the Railroad Commission was instructed to value the property of the various railroads as a preliminary to the approval or disapproval of the issue of additional securities. Valuations were made immediately of all roads then in existence and changes in the aggregate value of Texas railroads since that time have occurred only when new lines have been constructed. In other words, the valuation now so frequently quoted was made in 1894-6, when, following the panic of 1893, land, right-of-way, terminal facilities and construction materials were at their lowest prices. To present that original value as the present value of Texas ro^ds, as the Com- mission has done, is to refuse to give the roads any credit for permanent improvements, for the general settling and seasoning of their properties, or for the advance in value due to the general growth of the community to which the railroad has largely con- tributed. Whatever may have been the degree of overcapitalization in 1894, no comparison of an 1894 valuation with a 1909 capitalization can have the slightest validity. From 1896 to 1909 there was an increase in the Commission's valuation of Texas roads per mile of line of only 9.3 per cent. That this increase does not at all represent the actual increase in investment in Texas roads is shown by a study of gross earnings. Taking an average of the three years 1894-6 as a base, and comparing this with an average tor the three years 1907-9 there is found to be an increase in gross earnings per mile of road in Texas of 71.8 per cent. At the same time, capitalization (stocks and bonds) per mile actually decreased 22.24 per cent between 1896 and 1909. Mr. Charles S. Potts, Professor of Law in the University of Texas, in his monograph on Railroad Transportation in Texas, expresses the opinion that if a thorough revaluation were made of Texas roads, the margin between actual value and capitalized value would be wiped out in the case of many roads. He quotes Mr. R. A. Thompson, for many years chief engineer of the Texas Railroad Commission, in a hearing before the Interstate Commerce Commission, as asserting it to be his deliberate opinion that the physical property of Texas railroads, valued by the Commission at |17,000, was worth on an average |30,000 per mile of line. 13 It is of interest to observe that the Texas Railroad Commission in its more recent valuations has placed a higher value per mile upon railway property than in its earlier valuations. Between 1894 and 1896, forty-five roads with a mileage of 9,105 miles were valued at an average of $15,589 per mile. Between 1905 and 1909, thirty- seven roads, with a mileage of 1,678 miles, were valued at $22,227 per mile. It is significant that the Texas Tax Board in 1908 estimated the total value of railroad property, tangible and intangible, as $409,957,928 or $31,776 per mile of line. This board in its estimate includes all those elements of value which are omitted by the Rail- road Commission. For the reasons given, all figures for Texas are excluded as worth- less from the summary table at the end of this discussion. RECAPITULATION PHYSICAL VALUE Capxtalizatiok STATE Cost of REPRODtJCTION Present Valde Total Per Mile Total Per Mile Total Per Mile Washing'ton, 1905* South Dakota, 1908. . . Michigan, 1900 1907 $194,057,240 106,494,503 202,716,262 $64,343 26,933 25,946 $175,797,025 91,695,132 166,398.156 204,033,500 360,480,160 322,565,107 309,706,514 240,718,711 $58,283 23,190 21,298 24,456 47,454 42,463 40,770 33,910 $168,696,670 138,850,297 291,605,232 357,555,907 300,027,696 $53,267 35,116 37,323 42,857 Minnesota, 1907 — Estimate A 411,735,195 373,820,141 360,961,548 296,803,322 54,201 49,210 47,517 41,811 39,496 Estimate B 2 Wisconsin, 1909 311,819,128 44,167 ♦In Washington, a market value of $195,662,635, or $64,875 per mile, is also giYen. It should be kept clearly in mind by any one who uses the figures given in this pamphlet that this is not, and is not intended to be, a definite or an absolutely accurate statement of the relation of physical value to capitalization. Its purpose is to point out the difficulties of comparison of these two items within the limits of single states, and to resolve these difficulties so far as available statistics will permit. Further investigation would make possible the production of a multitude of illustrations of the injustice to the railways in most of these western states of the mileage pro-rate method of capital distribution. Although the figures given are those of physical value only, strong arguments might have been advanced 14 for the capitalization of intangible values. But this pamphlet was not designed as a discussion of the principles which should apply in a valuation of railways, nor as an exhaustive discussion of the statistical elements involved. DATE DUE LflATiir^"*":^*"^ mm^P^ ^■-f-S, ^. >V 4 CAYLORD PNINTEDINU.a A. 1