disapproved in Spring Valley Water Co. v. San Francisco, 165 Fed. 667, decided Oct. 7, 1908. This is a rate case. District Judge Farrington says (at page 696):

Two of the experts estimated the value of the going business to be equal to the total amount by which current rates of interest exceeded the net profits of the business prior to 1880. In other words, the value of the going business is equal to the cost of establishing the Spring Valley Water Company's business originally, and that cost is equal to the deficiency of revenue prior to 1880. This estimate is open to the objection that the deficiency of revenue may have been due to extravagant or wasteful management. The company may have purchased a plant larger and more expensive than necessary; current rates of interest may have been abnormally high; many causes which have absolutely no relation to the value of the company's business now as a going concern may have increased or diminished the deficiency in revenue. Furthermore, if it be conceded that early deficiency of revenue is the proper measure of value for the present going business, then it follows that, the greater the deficiency and the more unprofitable the business, the greater the present value of the going concern; and, if the business had yielded large profits from its very inception, the going business to-day would be worthless.

On final hearing of this injunction proceeding in 1911, the above was again cited with approval by District Judge Farrington, 192 Fed. 137, 166.

§ 615. New York Public Service Commission disapproves capitalization of early losses.

In the opinion of the New York Public Service Commission for the First District disapproving a plan of capitalization on reorganization of the Third Avenue Railroad Company a proposition to capitalize early losses is rejected. Commissioner Maltbie says:

9

• Re Reorganization of Third Avenue Railroad Company, 2 P. S. C. 1st D. (N. Y.)-July 29, 1910.

Mr. Floy has included interest and taxes not merely up to the time when operation begins, but also until the company can earn a sufficient surplus over and above operating expenses and interest to pay a reasonable dividend to the stockholders. According to this theory, the longer a company is unable to earn a fair profit for its stockholders, the greater will be the value of the property; but everyone knows that such is not the case. The same theory would justify stock dividends, for if a company is entitled to capitalize unearned dividends below a reasonable return, say six or eight per cent., it follows that it may issue securities for such unearned dividends. Would the converse be admitted by Mr. Floy, viz., that if a company earned a large amount above operating expenses, interest and fair dividends, such surplus should go to reduce capitalization? Such theories are neither sound nor practicable, and Mr. Floy could cite no case where they had been followed.

The applicants seem to have fallen into this error, through a failure to differentiate the present case from a rate case. It might be thought fair, if a rate were being fixed to allow a company which had failed to earn a fair return upon its unimpaired investment during the early years of its existence to make up these deficiencies by larger earnings during the later years. But this principle is entirely different from the one enunciated by the applicants.

The proper period for the capitalization of development expenses ends when operation actually begins. Securities ought not to be issued to cover operating expenses, fixed charges or dividends after that time, except possibly in a most unusual case when such procedure is absolutely necessary to preserve the undertaking. In such an abnormal case, repayment must be made sooner or later out of earnings, and a company which attempts to secure dividends that are not earned by the issuance of securities has started upon the road which leads to financial disaster.

§ 616. Report on Peoria waterworks rates, 1910.

After referring to Justice Brewer's opinion in the Kansas City Case (see above, § 521), Messrs. Benezette

and C. B. Williams in their report on the Peoria waterworks rates say (at page 25): 10

Now, what is this value which flows from the established connections? In what does it consist? Whence does it come? Judge Brewer did not give it a name, nor did anyone in Kansas City case, though some of the attorneys contended that the business, and the plant as a whole must be taken upon the basis of a "going concern."

Obviously it has to do with something that has economic value, that is the object of human desire, that is sought after. Something for which people will make sacrifice. No one will do this for "Deficits and Losses." One may incur "Deficits and Losses" to attain the sought for object, but they are not the object.

The object desired and sought in the case of public utilities is beyond dispute, service. A service whose value is represented, and measured by certain portion of the probable future earnings of the plant. .

What is it then but the earnings which the operating plant can and will produce in the future, which could not be obtained if such plant had had no existence? that is the difference in the net earnings of the operating plant, and the possible net earnings of a hypothetical plant if it were started to-day in the same though a new and unoccupied field?

§ 617. Conclusion.

If going value is to be allowed for at all as a separate element in the valuation, the Wisconisn rule for its determination has a great deal of merit. It is based on the real equities of the case. Necessary losses incurred in placing a business on a paying basis must if possible be reimbursed in some way. The Wisconsin rule includes such losses in the capitalization until such a time as they can be amortized out of earnings. While the rule is simple

10 Report to the Mayor and City Council on water rates for the plant belonging to the Peoria Water Works Company, Peoria, Illinois, by Benezette Williams and C. B. Williams, September 8, 1910.

enough in certain cases in other cases it is very complicated. It may require a knowledge of the life history of the plant and the manner and details of its operation and management that can not now be obtained. If the company had been subject to efficient regulation throughout its life there would be some assurance of having reliable data to work upon. Unless the data is reasonably complete and it is used with a great deal of discretion it may lead to very erroneous results. Aside from certain errors already referred to and in view of the difficulties involved, the Commission seems to have worked out and applied the rule with remarkable intelligence, discretion and fairness. As explained in § 642, it seems better in valuation for rate purposes to give proper consideration to early losses in establishing the business through an increment in the rate of return, yet even so the application of the Wisconsin rule is useful as one method of judging what increment in rate of return is fair under the circumstances. In cases of purchase and condemnation whatever allowance is proper for going value must be included in the price fixed as it can not be allowed for in the rate of return. For purchase cases, therefore, the Wisconsin method will often be of much value.

CHAPTER XXV

The Theory of Going Concern Value

630. Franchise and going concern in large measure inseparable. 631. Commercial value as a going concern.

632. Good will.

633. Good will a characteristic of competitive business.

634. Good will-Court decisions.

635. Good will-Wisconsin Railroad Commission.

636. Going concern value-Definition.

637. Methods of estimating going concern value.

638. Market value v. Cost as a measure of going concern value.

639. Cost of reproduction v. Actual cost as a measure of going concern

value.

640. Cost of establishing paying business-Rate Case.

641. Cost of subsequent promotion of business-Rate Case.

642. Going concern value-Rate Case.

643. Going concern value-Public purchase.

644. Cost of service theory of determining going value as set forth by Frank F. Fowle.

§ 630. Franchise and going concern in large measure inseparable.

The intimate connection between franchise value and going concern value is indicated by the fact that in purchase and condemnation cases there is usually no attempt to separate them. Either term is often used to indicate all intangible elements of value. In early condemnation cases these intangible elements in so far as they received separate consideration seem to have been lumped together as franchise value. In fact there was no development of the conception of going concern as a separate element entirely distinct from the franchise until cases of municipal purchase came up in which by agreement or on account of the expiration of the franchise it was impossible to include franchise value.