ment; that the interest paid on the capital legitimately invested should be sufficient to attract the necessary capital into these enterprises; and that the speculative and other gains should be high enough to induce employers to enter these industries as co-ordinators of the other factors of production therein and as assumers of all risks and responsibilities that are involved in their operation. From these facts there is no escape. From this it also follows that the rates fixed for the services rendered by such utilities must, in the long run, be high enough to attract the various factors of production, or to induce the employer to enter upon such enterprises and to become responsible for the risks that are involved.

§ 792. Ordinary method of financing in its relation to fair rate of return.

In considering a fair rate of return it is important to bear in mind that a large proportion of the capital of public service enterprises is furnished by the bondholders who receive only a prescribed rate of interest. The profits are divided among the stockholders who are supposed to assume the management and risks of the enterprise. A rate of return slightly in excess of the interest rate on the bonds will therefore bring to the stockholders a very fair dividend. This fact is clearly brought out by Commissioner Maltbie in delivering the opinion of the New York Public Service Commission for the First District in Mayhew v. Kings County Lighting Company, 2 P. S. C. 1st D. (N. Y.) —, decided October 20, 1911. He says:

The ordinary method of raising funds must also be considered, for money can be secured by the issuance of bonds at a lower rate than stockholders demand. Other things being equal, the rate of interest which must be paid increases as the proportion of the capital raised by the issuance of bonds increases. Under ordinary circumstances, a public service corporation would be conservatively financed if one-half or two-thirds of the funds needed were secured by first mortgage bonds and the remainder by

the issuance of capital stock. In a case such as the one now being considered, probably one-half of the cost of the plant could be raised by the issuance of first mortgage bonds upon a basis of from 5 to 6 per cent. As a matter of fact, the par value of the bonds of the present company is equal to the stock. It is also probable that a return of from 8 to 10 per cent. upon the stock would attract sufficient capital to provide the remainder.

The following table illustrates the results of certain combinations of the above factors:

To illustrate, assume that the amount of money to be raised is $3,000,000 that one-half of this amount will be raised through bonds and one-half through stock, that bonds are sold upon a 5 per cent. basis, and that a 9 per cent. return is necessary to attract stockholders. The interest and dividends would be as follows:

5 per cent. interest upon the bonds (par value $1,500,000)

$75,000

9 per cent. dividends on stocks (face value

$1,500,000).

135,000

Total interest and dividends

$210,000

This is equivalent to 7 per cent. upon the total value of the property, assumed to be $3,000,000, as shown by case 3.

The above table shows that in no case would the average rate of return upon the entire amount be over 8 per cent. unless

a higher rate of return were demanded than 6 per cent. upon the bonds and 10 per cent. upon the stock.

This fact is also brought out clearly in the extract from the paper by Frank F. Fowle quoted in § 644. The principle is applied by Judge Grosscup in Chicago Union Traction Company v. State Board of Equalization (see $735).

§ 793. Three standards of reasonableness.

A fair return may be determined (1) by such rate or rates as would have been fair and necessary to induce investment at the time or times when the original plant and its subsequent additions or improvements were in fact constructed; (2) by such rate as would under present conditions be necessary to induce investment in a new enterprise of exactly the same character; (3) by the current market rate or income basis on which the securities of the company can be sold.

§ 794. Original risk standard.

(1) Fair rate of return at the time the original investment was made. The pioneers in early railroad, gas, water or electrical enterprises were doubtless entitled to returns commensurate with the risks incident to entering untried ventures. The question is whether the rate of return deemed fair at the time the investment was made should continue permanently as the fair rate to which the investor is entitled. When the New York Gas Light Company was organized in 1823 the production of gas was an uncertain venture and investors must have had the prospect of large returns in order to induce them to go into the enterprise. The expected profits were in fact realized and subsequent investments in the gas business in New York City were made on a much less speculative basis. It would of course be ridiculous to assert that because the

first money invested in the gas business in New York City was entitled to earn, say 20%, that therefore all subsequent investment in the same enterprise was entitled to the same return. But is the actual investment which when made 90 years ago was entitled to 20% as a fair return, still entitled to such return? This also seems unreasonable. Although the pioneers in this enterprise expected large returns, they could not reasonably expect such returns in perpetuity. The pioneer who undertakes the manufacture of a new commodity expects if successful to secure for a time what are practically monopoly prices and monopoly profits; but he realizes that competition will very soon reduce such profits. His chief reward comes during the period before his success has induced others to follow his example. Even if the commodity manufactured is protected by a patent, the patent will expire in 17 years. It certainly does not seem necessary to assume that a municipal monopoly is entitled to the enjoyment of the larger rate of profit due the original investment for a longer period than the 17-year period that is granted the promoter of a new invention.

§ 795. Original risk standard-Court decisions.

The doctrine that the present fair rate return shall be based on what was a fair return at the time the original investment was made has practically no legal authority. The Pennsylvania Supreme Court, however, in its decision in 1908 in the Pennsylvania Railroad Rate Case, see § 746, refers to the great risks assumed by the original investors in 1846 and concludes that the rate of return is not necessarily regulated "by what others would now make the venture for under the present circumstances and with present knowledge." A ruling by Judge Savage in one of the Maine water plant condemnation cases seems to hold that while the risks of the original investors should

'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

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