Daily fluctuations can be cared for most accurately, probably, by finding the weighted mean value of all sales during the period chosen for examination. This can be found by dividing the total amount paid for the securities during the period of examination by the number actually sold. It is probable that in most cases the third cause of variation would not be the source of appreciable error if neglected, particularly if the period chosen for examination was sufficiently long. This fluctuation would not be present in the case of a bond sold "flat," and, if sales are quoted with accrued interest, the amount of accrued interest to the date of sale should be subtracted from such quoted price in order to obtain the true value of the bond itself for the sale. In the case of stock, it can be cared for, particularly if the stock is one which pays dividends with a fair degree of regularity, by reducing the market price for each sale by an amount equal to the expected accrued return, analogous to the accrued interest on bonds. The figures thus determined furnish one value based on commercial considerations to be used in an investigation as to fair present value. (For complete description of this method reference should be made to Bulletin 21, United States Department of Commerce and Labor.) 86. Method of ascertaining value based on capitalization of net earnings. This item is designed to meet Mr. Justice Harlan's requirement for figures showing "the probable earning capacity of the property under particular rates established by the statute, and the sum required to meet operating expenses." This item was summarized in section 5, as "Figures showing the commercial or capitalized value of the business of the undertaking based upon present as well as possible future earnings, i.e., the probable gross earnings less present or possible future operating expenses." Thus two sets of figures are to be presented in cases where a statutory rate has been imposed, one as of the earnings and operating expenses under prevailing rates, the other under the proposed statutory rate. For the present it will be necessary only to describe the first of these two sets of figures. There are two figures which require careful study in a determination of the capitalization of net earnings, one operating expenses, and the other the proper rate upon which the capitalization should be based. The net earnings are the gross earnings less operating expenses, taxes and reserves for depreciation. In any determination of the gross earnings for the purposes of valuation, both of these items should be examined with care to see that there have been included in them only such payments as should legitimately be charged as expenses. Thus many undertakings have charged extensions of the plant to operating expenses and, thereby, reduced the net earnings by amounts which should have been charged directly to the cost of the plant. In other cases insufficient amounts have been laid aside as depreciation reserves. It will be seen that it will usually be an extremely difficult question to determine what the proper depreciation reserve should be unless this method of valuation is pursued in connection with an appraisal which shows the replacement cost and depreciation of the physical property of the undertaking. In such a case, the depreciation reserves can be estimated with a reasonable degree of accuracy. The proper rate of return upon which the capitalization of net earnings should be based is the rate of return which the investing public is willing to receive for that particular security. Thus if the market value of the stock of the undertaking under appraisal has been found by the method described in the last section to be 50 per cent above par value and the return paid stockholders is 6 per cent on the par value, then clearly the stockholder figures 4 per cent as the fair rate of return on his investment. The proper net return capitalized on a 4 per cent basis would give therefore the commercial value of the undertaking. If the stock stood below par and paid no dividends, then clearly it would have speculative value only and could be given no commercial value on this basis, and reliance would have to be placed largely upon the prices of the securities as sold on the market. It should be noted that the rate upon which capitalization is to be based should be determined with the greatest possible accuracy, for the reason that a slight variation in the rate may cause an enormous variation in the capitalized value. It is necessary, therefore, that the present market value, one of the quantities essential to the determination of the rate for capitalization, should be found freed from all fluctuations and should be determined to as many significant figures as may be necessary to secure the required accuracy. 87. Liabilities. The usual form of a corporation balance sheet is shown below. Figures have been introduced for ease of explanation. It will be noticed that the figures derived to show original cost and replacement cost were designed to be used as checks upon the plant account, the principal item in the assets of the undertaking. Working capital consists of cash and supplies plus "Bills and Accounts Receivable." This sum in a valuation must be reduced by "Bills and Accounts Payable" which is carried on the books as a liability. Working capital can be obtained directly from the books of the undertaking and is presented with the other figures as an asset. The only question involved in working capital is whether or not it is of proper amount for the successful conduct of the business of the undertaking. Securities of outside organizations or quick assets of any kind are also entered with the other property but are properly securities held to make good the losses in value of the plant investment in perishable property. The tribunal has, therefore, two figures to test the trial balance of the undertaking, - original cost plus two constants, working capital and outside securities; and replacement cost plus the same two constants. The demand of the court for figures to show the par value of the stocks and bonds is for the purpose of comparing the actual liabilities of the undertaking with its assets as given not only by the company's books but by the original cost and replacement cost plus the constants above described. The item of "Reserves Depreciation of Plant," which is shown as a liability, is always difficult for one who is not an accountant to understand. In order to eliminate this difficulty, the above supposititious trial balance can be shown in a form which would present the financial condition in a manner suitable in an appraisal. |