be considered, the higher return thus merited should be limited to a reasonable period and that it should not in any case be allowed if the earnings have in fact been sufficient to compensate for the initial risks. Judge Savage says: 13

There is another matter which we think may fairly be considered in connection with the reasonableness of rates. We think something may be allowed in this respect for the risks of the original enterprise, if there were any. It is common sense that they who invest their money in hazardous enterprises may reasonably be entitled, for a time, at least, to larger returns than would be the case if the success of the undertaking were assured from the beginning. The plaintiff, in request 11, concedes that such risks may be considered in valuing the franchise. But inasmuch as the value of the franchise depends chiefly upon the net income which may be produced by its exercise at reasonable rates, as has already been stated, it follows, we think, that the reasonableness of the rate may be affected by the degree of risk to which the original enterprise was naturally subjected. This does not mean unforeseen or emergent risks, but such as may have been justly contemplated by those who made the original investment. We use the word "chiefly," because we apprehend that a franchise, even of an unprofitable business, might have a temporary value for some purposes. But that condition does not seem to exist in this case. The element of risk, however, is not controlling. It is only one element. It is to be fairly considered in connection with the other

13 Kennebec Water District v. City of Waterville, 97 Me. 185, 54 Atl. 6, 14, December 27, 1902, Supreme Judicial Court of Maine. In this case the court lays down rules to govern appraisers in making a valuation of the property of the Maine Water Company for purposes of purchase by the Kennebec Water District. The court while complying with the provisions of a state statute providing for such purchase, appreciates the possible difficulties if not dangers in attempting to formulate rules which are to be applied to facts not yet ascertained. This is the first of two similar cases, the second one being that of the Brunswick Water District, decided in

elements named. To say just how much allowance should be made, and for how long a period, requires the exercise of a careful, conservative, and discriminating judgment. If allowance be sought on account of this element of original risk, we think it will be permissible at the same time to inquire to what extent the company has already received income at rates in excess of what would otherwise be reasonable, and thus has already received compensation for this risk.

$796. Standard of present risk for new enterprise.

(2) Rate of return adequate to induce investment in a new enterprise at the present time. This is the rate that prevails in competitive industry. The rate of return is practically governed by the return at which there will be a free flow of capital into the business. If the rate is higher, excess capital will be attracted and through competition the average rate of profit will be reduced to the normal rate. If the average rate of return is too low, capital will cease to flow into the business until through exhaustion of existing capital or a demand for increased capital the rate of return is increased to the normal rate. The same test may with considerable reason be applied to the determination of a fair rate of return for public service corporations. This is not because it is desirable to induce competition in the supplying of public services, for that theory has been generally abandoned. It is based rather on considerations of justice and public policy. While the state has no desire to induce another gas company to compete with an existing gas company it is desirous of securing a free flow of capital into the gas industry for the improvement and extension of existing plants and the construction of plants in new communities. There is considerable force in the argument that the best way to do this is to permit the capital at present in the business to earn the rate of return that is deemed adequate to induce such new investment.

§ 797. New enterprise standard-Approval by commissions and courts.

This seems to be the standard that finds most favor with the state regulatory commissions. It is indicated in the opinion of the Wisconsin Railroad Commission in State Journal Printing Company v. Madison Gas and Electric Company quoted in § 791; in the opinion of the Interstate Commerce Commission, in Spokane v. Northern Pacific Railway Co. quoted in § 753; in the opinion of the Nebraska State Railway Commission in Lincoln Traction Company case, quoted in § 765; and is expressed as follows by Commissioner Maltbie in the decision of the New York Public Service Commission for the First District In re Queens Borough Gas and Electric Company, 2 P. S. C. 1st D. (N. Y.), decided June 23, 1911:

Various standards have been suggested for determining the fair rate of return. The one which in our opinion is properly applicable to this case is that the rate should be such that investors would be induced to provide the funds with which to construct and extend a gas and an electric plant within the area in question. If the state were to fix a rate below this standard, capital could not be secured. If investment were made before the state acted, the original capital might be forced to remain, but additional capital could not be secured unless necessary to protect the first outlay.

On the other hand the courts have usually adopted a rate of return lower than that which would be produced by the application of the above standard. In Columbus Railway and Light Company v. City of Columbus, quoted in § 743, the special master refers to this as the administrative standard but holds that the judicial standard for testing the constitutionality of an ordinance must be based on the narrower grounds of prevention of actual confiscation. On the contrary the Appellate Division of the New York Supreme Court in the Saratoga Springs Gas

Rate Case (quoted above, § 745) apparently approves this

standard.

$ 798. Present market rate standard.

(3) The market rate indicated by the income basis on which the securities of the company are bought and sold. This corresponds to the rate of return that would make the market value of the securities substantially equal to the actual investment. It is the rate of return that would make the market value of the property substantially equal to the fair value of the same for rate purposes. The question is what return do actual investors at present demand when purchasing the stocks and bonds of the company. If the total capitalization is made up of one-third stock and two-thirds bonds and the bonds can be sold on a 5% return basis and the stock on an 8% return basis, the average for both stocks and bonds is 6%. If the company were allowed 6% as a fair return it would be enabled to pay 5% on the two-thirds of its valuation represented by bonds and 8% on the remaining one-third represented by stock. The market value of its securities would accordingly be maintained at the same total as the fair value of its property for rate purposes. This method of determining a fair rate of return is applied by Circuit Judge Grosscup in Chicago Union Traction Company v. State Board of Equalization, quoted in § 735. This was a tax case and is therefore of value as illustrating the method rather than as establishing a precedent. There is no direct judicial precedent for the use of this method in a rate case. It seems probable, however, that some such mental process as this has influenced the numerous decisions of the courts holding 5% or 6% a fair return or at least as a non-confiscatory return. This seems to be the underlying thought of Judge Hough and Justice Peckham in their opinions in the Consolidated Gas Case (see §§ 750,

751). Although not followed in later decisions (see § 791) the above standard for determining a fair return is clearly stated by the Wisconsin Railroad Commission in Buell v. Chicago, Milwaukee and St. Paul Railway Company, 1 W. R. C. R. 324, decided February 16, 1907. The Commission said (at page 477):

It has been quite generally held that a fair rate of interest is a rate which, other things being equal, corresponds to the current market rates on money. This is a position with which it is not easy to take issue, for it is quite clear that whatever rate money brings in the market is a safe index to what it is generally worth for investment purposes. It may also be said, and with a great deal of force, that a fair rate of interest for any particular road is the rate of income which its securities bring on their market value. The market rate includes the ordinary risks, as it is usually considerably higher than the rate which is obtained on government and other securities where substantially no risks at all are involved.

$799. Conclusion.

It seems probable that in determining the fair rate of return each of the above three standards may be used for different cases, but that most cases will require the application of a composite standard. A first essential to clear thinking on this matter is the recognition of the fact that the fair rate of return depends very largely on the method adopted for the treatment of the cost of establishing the business and the franchise. If the cost of establishing the business has been capitalized and added to the fair value for rate purposes there will of course be no necessity for again allowing for the same thing in the rate of return. The prospect of early losses is one of the important risks of the original investor but if considered as a risk in determining the fair rate of return it can not also be capitalized as cost of establishing the business as that results in double pay. The franchise secures to the investor the