Moines, 72 Fed. 829, decided January 8, 1896, the court says (at page 842):

So that, confessedly, a part of the bonds was issued for patents not used at all by plaintiff. Manifestly, these should not be included in arriving at the basis we are now seeking. Nor should there be included any amounts expended or investments made by plaintiff in its attempt or experiment, however laudable these attempts may have been, to supply fuel gas to the citizens of Des Moines, and which were expended or invested in directions not now required, or not properly serviceable for the company's present uses. These must be laid aside, among any other unprofitable investments in the history of the company. These may evidence the creditable desire of the company to keep its works fully abreast with progressive idea of gas making. But they are now of no market value. In other words, the court may not now regard the rates as properly to be increased above what would otherwise be reasonable for the purpose of allowing plaintiff to recoup losses heretofore incurred in any unfortunate or unprofitable investments it has made, or to charge and receive interest on losses thus incurred. In this connection I wish to say that the proof presented on the hearing fully absolves the plaintiff from any rascality on the part of those engaged in the construction or management of plaintiff's property.

§ 461. United States Circuit Court in Milwaukee Street Railway Fare Case, 1898, holds superseded horse car equipment entitled to equitable consideration.

In Milwaukee Electric Railway & Light Company v. City of Milwaukee, 87 Fed. 577, decided May 31, 1898, Judge Seaman says (at page 585):

I am satisfied that the property of complainant represents the value, based solely upon the cost of reproduction, exceeding $5,000,000. And I am further satisfied that this amount is not the true measure of the value of the investment in the enter

prise. It leaves out of consideration any allowance for necessary and reasonable investment in purchase of the old lines and equipments, which were indispensable to the contemplated improvement, but of which a large part was of such nature that it does not count in the final inventory. No allowance enters in for the large investment arising out of the then comparatively new state of the art of electric railways for a large system, having reference to electrical equipment, weight of rails, character of cars, and the like, of which striking instance appears in the fact that the electric motor which then cost about $2,500 can now be obtained for $800; so that work of this class was in the experimental stage in many respects, and the expenditures by the pioneer in the undertaking may not fairly be gauged by the present cost of reproduction. Of the $5,000,000 and over paid for the acquisition of the old lines, it would be difficult, if not impossible, from the testimony, to arrive at any fair approximation of the share or amount of tangible property which enters into the valuation in this inventory. It does appear that the roadways required reconstruction with new rails and paving, and that the amount stated was actually paid by the investors, making their investment nearly $9,000,000. How much of this may be defined or apportioned as the amount which was both "really and necessarily invested in the enterprise" (vide Road Company v. Sandford, supra) I have not attempted to ascertain, except to this extent: That I am clearly of opinion that at least $2,000,000 of those preliminary expenditures are entitled to equitable consideration, as so invested, beyond the reproduction value, if the valuation of the investment is not otherwise found sufficient for all the purposes of this case, but no opinion is expressed in reference to the remaining $1,885,644.

§ 462. United States Supreme Court declares that past supersession may not be included.

In Knoxville v. Water Co., decided January 4, 1909, the United States Supreme Court clearly lays down the rule that in a valuation for rate purposes there should be no addition to cover losses due to past functional depre

ciation or supersession. Justice Moody in delivering the opinion of the court says (at page 13):7

The company's original case was based upon an elaborate analysis of the cost of construction. To arrive at the present value of the plant large deductions were made on account of the depreciation. This depreciation was divided into complete depreciation and incomplete depreciation. The complete depreciation represented that part of the original plant which through destruction. or obsolescence had actually perished as useful property. The incomplete depreciation represented the impairment in value of the parts of the plant which remained in existence and were continued in use. It was urgently contended that in fixing upon the value of the plant upon which the company was entitled to earn a reasonable return the amounts of complete and incomplete depreciation should be added to the present value of the surviving parts. The court refused to approve this method, and we think properly refused. A water plant, with all its additions, begins to depreciate in value from the moment of its use. Before coming to the question of profit at all the company is entitled to earn a sufficient sum annually to provide not only for current repairs but for making good the depreciation and replacing the parts of the property when they come to the end of their life. The company is not bound to see its property gradually waste, without making provision out of earnings for its replacement. It is entitled to see that from earnings the value of the property invested is kept unimpaired, so that at the end of any given term of years the original investment remains as it was at the beginning. It is not only the right of the company to make such a provision, but it is its duty to its bond and stock holders, and, in the case of a public service corporation at least, its plain duty to the public. If a different course were pursued the only method of providing for replacement of property which has ceased to be useful would be the investment of new capital and the issue of new bonds or stocks. This course would lead to a constantly increasing variance between present value and bond 7 Knoxville v. Water Company, 212 U. S. 1, 29 Sup. Ct. 148, 53 L. ed. 371, January 4, 1909.

and stock capitalization-a tendency which would inevitably lead to disaster either to the stockholders or to the public, or both. If, however, a company fails to perform its plain duty and to exact sufficient returns to keep the investment unimpaired, whether this is the result of unwarranted dividends upon overissues of securities, or of omission to exact proper prices for the output, the fault is its own. When, therefore, a public regulation of its prices comes under question the true value of the property then employed for the purpose of earning a return cannot be enhanced by a consideration of the errors in management which have been committed in the past.

§ 463. Street railway supersession excluded in capitalization case-New York Public Service Commission, 1910. Re Third Avenue Railroad Reorganization Plan, 2 P. S. C. 1st D. (N. Y.) —, decided July 29, 1910, relates to the approval of capitalization upon a reorganization. The applicants claimed the right to capitalize superseded horse car and cable equipment. In denying this claim Commissioner Maltbie says:

Closely associated with the above theories is the argument advanced by the applicants that as certain lines started as horsecar lines and as a few were changed into cable roads and then into electric roads, the new company should be allowed to capitalize not only the present value of the property actually taken over but the cost of the horse-car lines and the cable roads that have disappeared. . . .

It is intimated that one reason for so doing is that it would have been difficult, and perhaps impossible, for the old company to have written off out of earnings the cost of the property which has disappeared. The difficulty has not been established as a fact; indeed the contrary seems to be true. During the period of horse-car operation, the Third Avenue Company declared dividends averaging about 13 per cent., ranging from 81⁄2 per cent. to 25 per cent. During this period, the company could have amortized or accumulated by sinking fund a sufficient

amount to have paid off the entire cost of the road as set forth above, and still have paid dividends of over 8 per cent. and founded a reserve fund besides. From 1891 to the time when electrification began, the average rate of dividend was somewhat less; and from 1900 to date the dividends have been very small. But the capitalization of the company represented not actual plant investment, but large premiums paid for stocks, interest charges and even operating expenses, as set forth in the previous pages. If from the beginning a reasonable amount as depreciation had been set aside out of earnings to take care of the various changes which have taken place, if the company had been conservatively financed and expenditures carefully watched, it is probably true, that dividends of 6, 7, or 8 per cent. could have been declared and yet a sufficient amount have been accumulated to write off the old horse-car and cable roads that have disappeared.

However, it is the first duty of every company to see that its capital investment is kept intact. All charges for repairs, renewals and replacements should be met out of earnings, and dividends should not be paid until these expenses have been provided for in some way. It is evident that the Third Avenue Railroad did not do so, but issued new stocks and bonds instead. The result was that its capital was depleted, that it could not pay the interest on its bonds and that the property has been sold under foreclosure.

The mill owner who has seen his machinery change decade by decade, who has seen revolutions in the arts which have compelled him to scrap his equipment several times, would be interested to know that he ought not to have charged the cost to operating expenses or accumulated surplus, but that he should have issued stock or bonds against these numerous replacements. It would be news to him to learn that he is entitled to earn a return upon not only his present plant but upon the half-dozen plants that have preceded the present one and have been destroyed. He knows that if he tried such a plan, came to bankruptcy, and found his property sold at foreclosure sale, the purchaser would not pay him for the property that had disappeared.