valuation purposes. A closer parallel, however, is the case of a water supply plant that has secured the most economical source of supply. Any competing company would have to obtain a supply from a much more distant source, thus greatly increasing the capital cost. It has been claimed that in a rate case the fair value of the water plant is not its cost but the greater cost of the new plant. This claim was denied by District Judge Farrington in his opinion in Spring Valley Water Works v. San Francisco, 192 Fed. 137, decided October 21, 1911 (quoted below, § 78). It is inconsistent with what is believed to be the governing principle of justice and equity which forms the basis of public service control, that rates should be increased in order to pay a return on the capitalized value of exclusive location or other monopoly advantage that represents no actual investment. A railroad exercises the right of eminent domain to secure its location and the right of eminent domain can only be lawfully exercised for a public purpose. The location secured by this method for a public purpose cannot justly create a monopoly that will be capitalized against the very public purpose that it was intended to serve the transportation of freight and pas

sengers.

§ 57. Reasonable rates cannot be based on market value. By the above method rates are based on physical cost, but not necessarily on the cost of the road itself, but in many cases on the cost of a competing or hypothetical road. Market value has nothing to do with the rate question as thus considered. It is only set up after the rates are in fact determined. To be sure, the theory is that rates are based on a fair return on the market value of the road under reasonable rates. The impossibility of basing reasonable rates on a market value that is itself determined by reasonable rates is apparent. It is a clear

case of reasoning in a circle. We have the evident absurdity of requiring the answer to the problem before we can undertake its solution. The advocates of the market value theory cannot really mean what they say. Market value is not really a part of the process but the final result. It includes in many cases a capitalization of certain monopoly profits and the monopoly value thus created is set up as justifying the higher rates which have in fact created the monopoly value. A difficulty in the consistent application of the market value theory is illustrated by the following: The Washington Railroad Commission determines the present cash market value of the railroad (see § 52) and then fixes rates so as to allow the company to earn a return of 7% (see § 769) on this market value. The query is whether this determination does not immediately create a new and higher cash market value and therefore require an immediate increase in the rates just established. This will be true if the capitalization rate which actually determines market value is lower than 7%. If, for example, the capital of the railroad in question consists of two-thirds bonds and one-third stock, and if the 5% bonds sell at par and the stock can be sold on a 7% income basis, then the present cash market value of this road will be increased under the rates and rate of return fixed about 17% above the "present cash market value" fixed by the Commission.

§ 58. The misplaced or partially obsolete plant.

While it is clear that market value as above considered is not a proper general standard of value for rate purposes it is possible that it may have some merit in the valuation of a misplaced or partially obsolete plant. This is referred to the report of Commissioner Lawrence of the Washington Railroad Commission above quoted (§ 51) and is also discussed in the report of the Valuation Committee

of the National Association of Railroad Commissioners, in October, 1911, as follows: 4

The misplaced or partially obsolete plant or road is the one that causes greatest difficulty in valuations for any purpose. A waterworks plant has been built for a village too small to support it and the population of the village instead of increasing as expected actually decreases. A railroad has been constructed chiefly to carry coal from certain mines or lumber from a certain district. The coal or the timber becomes exhausted leaving a railroad that cannot pay a fair return on its actual cost or its reproduction cost no matter what the scale of rates charged. A street railway is constructed chiefly to carry passengers to a certain terminal, but currents of travel having changed, it can not possibly earn interest on its actual cost. Under such conditions the plant or line as a whole must be recognized as partially obsolete, and the best gauge of its present depreciated value will in many cases be its fair market value. Cases of this kind are frequently met with in valuation for tax purposes. A general reduction in the rates of a road or plant of this kind seldom comes up for official consideration but it very frequently happens in valuing any comprehensive railroad or street railway system for rate purposes, that there are certain lines that are partially obsolete though the system as a whole is earning a profit. For such partially obsolete, or partially used lines, neither actual cost nor reproduction cost, nor reproduction cost less existing physical depreciation, furnish any basis for fixing fair value for rate purposes. The value that will be most appropriate will be a value based on the earnings of the line as a part of the system and will thus be closely related to market or commercial value. But though in a rate case we can, as above, base the value of a particular part of a comprehensive system. on earnings or market value, we can not base the value of the whole system on market value, as the market value depends on the scale of rates charged, and the rate scale is the question at

National Association of Railway Commissioners, Proceedings of the Twenty-third Annual Convention, October, 1911, p. 148.

issue. The market value of the system will depend largely on the net return that may be earned under the rate scale allowed.

Rates in the case of the misplaced or partially obsolete plant or road cannot be based primarily on the value of the property but on what the service is reasonably worth and this in most cases is the amount that the consumer can reasonably afford to pay. The determination of the amount that the consumer can reasonably afford to pay is a process for which no rules can be laid down. It is usually determined in practice by noting the effect of rate variations on the volume of traffic. The net return resulting under reasonable rates as thus determined may be capitalized to determine the market value of the plant or road; but it is to be noted that value is here based on rates, not rates on value.

§ 59. Same subject-San Francisco Water Rate Case, 1911. In the case of Spring Valley Water Works v. San Francisco, 192 Fed. 137, decided October 21, 1911, District Judge Farrington states that in certain cases "fair value" means the value upon which a fair return can be earned at reasonable rates, and seems to recognize the need of a special standard in the case of the misplaced or partially obsolete plant. Judge Farrington says (at pages 154-155):

It is impossible to consider the constant use of the word "fair" or the word "reasonable," in connection with value, by all the federal courts and the courts of this state in practically every recent statement of this rule, without feeling that regard must be given to the service performed by the property; that reasonable value and fair value are not always and under all conditions the precise equivalent of full actual value, or the value which would be awarded in condemnation proceedings; that the value upon which a fair return is due is the value which under all the circumstances is reasonable and fair as between the public and the person who has voluntarily devoted his

property, or some portion or use thereof, to public convenience.

§ 60. Market value the true standard-Justice Brewer in Reagan v. Farmers' L. & T. Co., 1894.

In Reagan v. Farmers' Loan & Trust Company, 154 U. S. 362, 14 Sup. Ct. 1047, 38 L. ed. 1014, decided May 26, 1894, Justice Brewer says (at page 410):

The equal protection of the laws-the spirit of common justice -forbids that one class should by law be compelled to suffer loss that others may make gain. If the State were to seek to acquire the title to these roads, under the power of eminent domain, is there any doubt that constitutional provisions would require the payment to the corporation of just compensation, that compensation being the value of the property as it stood in the markets of the world, and not as prescribed by an act of the legislature? Is it any less a departure from the obligations of justice to seek to take not the title but the use for the public benefit at less than its market value?

§ 61. Market value standard impracticable-California Supreme Court in San Diego Water Case, 1897.

San Diego Water Company v. City of San Diego, 118 Cal. 556, 50 Pac. 633, decided October 9, 1897, is a case involving a valuation for rate purposes. The lower court held the municipal ordinance unconstitutional but was reversed by the Supreme Court and the cause remanded for a new trial. Judge Van Fleet in the majority opinion says (at page 568):

The judicial test of market value depends upon the fact that the property in question is marketable at a given price, which, in turn, depends upon the fact that sales of similar property have been and are being made at ascertainable prices. But such property as this is not so sold, at least not often enough to furnish a fair criterion; and the very fact of governmental regulation would necessarily control the price. Until