§ 722. Franchise value in condemnation cases. It is well established that franchise value must be considered in condemnation cases. The earlier cases indicate that franchise value is to be based largely on a capitalization of present or prospective earnings. Some of the more recent decisions, however, state that such value should be based largely, not necessarily on actual or prospective earnings, but on earnings under reasonable rates. Which of these rules shall finally prevail is a matter of considerable importance. When the earlier cases were decided the possibility of efficient rate regulation was hardly thought of. With the modern conception of the rights and obligations of public service corporations and the modern development of rate regulation it seems probable that certain legal conceptions will have to be modified to conform to these more fundamental principles. The market value of a franchise is of course affected by the fact that rates are subject to regulation. But if there has been no such regulation in the past and there is no present agitation for it, the practical effect on market value of possible future regulation is comparatively small. An investor purchasing the plant will pay something for the probability of excess profits during the years when profits are not kept down by rate regulation to a minimum reasonable return. But because an investor will take this chance is no good reason why it should increase the price to be paid by the public on a taking by condemnation. Condemnation is one method of regulation; rate making is another. It is no more just or unjust to destroy values created by the nonexercise of the rate making power by the right of condemnation than by a subsequent exercise of the rate making power. If it is just to destroy the hopes of the investor for a continuance of exorbitant profits through the exercise of the rate making power it is also just to destroy such misplaced hopes through the exercise of the right of condemnation. Now as brought out in Chapter 27, the weight of authority and practice is strongly against the inclusion of an allowance for franchise value in a valuation for rate purposes. This rule taken in connection with the rule above stated that in a condemnation case the value of the franchise should be based on earnings under reasonable rates makes it necessary in a condemnation case to proceed somewhat as follows. It is first necessary to determine what the earnings would be under reasonable rates. This is determined by estimating the fair value for rate purposes (with no allowance for franchise) and allowing upon such valuation a fair return. This return should be just compensation for the service rendered. When the property is taken, the thing of value of which the owners are deprived is simply the right to receive this amount of earnings. The question is what is just compensation for depriving the owner of the earnings to which he is justly entitled for constructing the plant and developing the business. Rate making involves the determination of the annual sum which may be deemed just compensation to the investors. Condemnation involves the determination of the total amount which may be deemed just compensation for or a commutation of, these annual payments. If this total amount is greater than the cost-of-reproduction-less-depreciation the difference may be attributed to going concern and franchise value. The permanence of the franchise value is of course directly dependent on the continuance of a rate of return in excess of that demanded for an assured investment. The present worth of the franchise is directly dependent on the length of time such excess rate of return may be reasonably assumed to continue.1 1The question of permanency of rate of return is discussed in §§ 794, 799. The above discussion is not intended to cover limited term franchises. CHAPTER XXX Rate of Return § 730. Relation of rate of return to fair value for rate and purchase pur poses. 731. United States Supreme Court, 1894-Railroad entitled to some profit. 732. California Supreme Court, 1897-Some margin over lowest rate for borrowed money. 733. Minnesota Supreme Court, 1897-22% on terminals and 5% on other railroad property not confiscatory. 734. United States Circuit Court, 1898-42% return confiscatoryStreet railway. 735. United States Circuit Court, 1902—6% a fair return-Street rail way. 736. Iowa Supreme Court, 1902-4.4% to 5%% not confiscatoryWater Company.. 737. United States Circuit Court, 1903-5% minimum rate-Water Company. 738. United States Circuit Court, 1903-Legal rate of interest the minimum rate-Railroad. 739. United States Supreme Court, 1904-6% return is not confiscatory -Irrigation Company. 740. United States Circuit Court, 1904-5% minimum return-Water Company. 741. Maine Supreme Court, 1904-Reasonable rate dependent on circumstances. 742. New Jersey Court of Chancery, 1905-5% minimum returnWater Company. 743. United States Circuit Court, 1906-Legal rate of interest (6%) the minimum rate-Electric Company. 744. United States Circuit Court, 1907-7% a fair return-Telephone. 745. New York Appellate Division, 1907-Saratoga Springs Gas and Electric Rate Case. 746. Pennsylvania Supreme Court, 1908-Legal rate of interest (6%) the minimum-Consideration of rate necessary to induce original investment. 747. United States District Court, 1908-Legal rate of interest (8%) the minimum fair return-Railroad. 748. United States District Court, 1908-5% a reasonable returnWater Company. 749. Consolidated Gas Case-State commission holds 8% a fair return. 750. Consolidated Gas Case-District Judge Hough holds 6% a fair return. 751. Consolidated Gas Case-United States Supreme Court holds 6% a fair return. 752. United States Supreme Court, 1909-Not decided whether 4% return would or would not be confiscatory-Water Company. 753. Interstate Commerce Commission, 1909-Railroad entitled to considerably more than 4%. 754. United States District Court, 1909-6% a fair return for railroad. 755. United States District Court, 1909-6% a minimum return-Gas plant. 756. New York Court of Appeals, 1909-Legal rate of interest (6) a fair return-Water Company. 757. United States Circuit Court, 1909—6% a reasonable return-Water Company. 758. United States District Court, 1909-6% a reasonable return-Telephone Company. 759. Iowa Supreme Court, 1909-5% to 6% a reasonable return-Gas Company. 760. Oklahoma Corporation Commission, 1911-8% a fair return Telephone. 761. Chicago Gas Rate Report, 1911-6% v. 7% as a fair rate of return. 762. United States Circuit Court, 1911-7% the minimum reasonable return-Railroad. 763. United States Circuit Court, 1911-7% the minimum reasonable return-Telephone. 764. United States Circuit Court, 1911-6%, plus 12% for lean years, a fair return-Railroad. 765. Nebraska State Railway Commission, 1911-8% a fair returnStreet railway. 766. United States District Court, 1911-3.97% return is confiscatory -Water Company. 767. Arkansas Supreme Court, 1911-6% to 10% a fair return-Legal rate of interest-Electric Company. 768. Missouri Supreme Court, 1911-6% a reasonable return-Telephone. 769. Washington Supreme Court, 1911-7% a fair return-Electric railway. 770. United States Circuit Court, 1911-8% a fair return-Water Com pany. 771. New York Court of Appeals, 1911-Fair rate of return a question of fact to be determined by lower court-Tax Case. 772. New York Public Service Commission for the District First-72% a fair return-Gas Company. 784. Review of attitude of Supreme Court of the United States 785. Review of attitude of federal and state courts. 786. Attitude of courts and commissions contrasted. 787. Distinction between fair return in an administrative and judicial sense. 788. Same distinction upheld by California Supreme Court, 1911. 789. Federal court in San Francisco Water Rate Case, 1908. 790. Responsibility of regulatory commissions. 791. Elements of a reasonable return-Wisconsin Railroad Commission. 792. Ordinary method of financing in its relation to fair rate of return. 793. Three standards of reasonableness. 794. Original risk standard. 795. Original risk standard-Court decisions. 796. Standard of present risk for new enterprise. 797. New enterprise standard-Approval by commissions and courts. 798. Present market rate standard. 799. Conclusion. 800. The sliding scale and other automatic methods of securing voluntary rate reductions and of rewarding efficient management. § 730. Relation of rate of return to fair value for rate and purchase purposes. The rate of return is a very important factor in a valuation either for rate purposes or for purposes of public purchase. In a rate case, as has already been pointed out, the justice of the result does not depend on the fair value alone or on the rate of return alone but on the total return or net income allowed, which is the product of the fair value and the rate of return. In a rate case certain equities may be provided for either in the fair value or in the rate of return. If they have been considered in the rate of return it would be duplication to allow for them again in the fair value and vice versa. These two factors are therefore interdependent and must be considered together. In a purchase or condemnation case the valuation is all important. But even here the determination of a fair rate of return will often be an essential preliminary in fixing the valuation. It has been held that net income under reasonable rates is probably the most important |