CHAPTER XIII

FAIR PRESENT VALUE - CONDEMNATION OR SALE

170. Market value.

171. Fair cost-new.

172. Increased cost of maintenance.

173. Uncertainty as to life.

174. Value of franchise.

175. Depreciation in cases of sale.

176. Investment of buyer must be full cost-new of a public utility prop

erty.

177. Present value in case of sale.

170. Market value. The methods of determining fair present value, which have been described in the preceding pages, are those which apply in cases of rate regulation in the case of a utility which is to continue to furnish the service to the public. The question next to be discussed is whether the same methods are applicable when it is required to determine the fair present value in a case involving the condemnation or sale of the property of a public utility.

The principle underlying the sale of an ordinary commodity is that the fair price is such a sum of money as would be paid by a willing buyer, having the necessary funds, to a willing seller. In the case of the sale of a public utility undertaking, this same principle holds good, except that there is introduced the interests of a third party or group, the users of the utility or, as it will be termed, the public. The rights of the public must be conserved by such a regulation of the price paid that the amounts, which must be paid by the public in the form of rates for the use of the service and for its continuation, preciation reserves, must not be enhanced. The fair

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present value of the property of a public utility undertaking in a case of sale, therefore, must be such a price as is fair to the public as well as to the seller and to the buyer.

171. Fair cost-new. In most cases, as far as the appraiser is concerned, it will be necessary to prepare and present the same figures as would be presented were the case one affecting rates. It is true that, strictly speaking, original cost in a case of sale would not seem to be of importance, for the buyer cannot be concerned with what the property had cost the original owner. This assumption arises naturally from the association in the minds of most students of this subject with the sale of a private enterprise. But in the sale of a public utility the public must be considered, and fairness to it demands that the price paid by the vendee shall not be such as will impose new higher or unfair rates.

When the interests of the public are considered, there seems to be no reason to believe that the fair cost-new in the case of sale should not be the same as would be assigned to the property as fair cost-new for rates provided that figure had been obtained with the well informed judgment described in the last chapter. This figure, therefore, would be not necessarily the original cost, not necessarily the cost-of-reproduction-new as of the present time, not necessarily the capital value of the assets nor of the return capitalized. It would be such a figure as would be fair to the seller and public under the special conditions affecting the property under consideration.

A value based upon such a cost-new might seem to those familiar with the sale of private undertakings as imposing a burden upon the buyer. The buyer assumes the ownership and operation of a property which has been some years in existence. It is natural for him to contrast such a property with a new one and look upon

the existing plant as second-hand and that, since the plant is not new, he is entitled to a lower or bargain price. The buyer may argue that the cost of maintenance increases with age and that, as he is buying an older plant, some recognition should be made of the increased expense of maintenance which he will have to assume. Moreover, he may demand that he should pay a lower price for the plant due to the fact that he is obliged to incur a certain amount of risk arising from the possibility that the life assigned to the plant may be wrong and, consequently, that he may have to incur the cost of the renewal of some portions of the plant before he has had the time necessary to accumulate the needed reserves.

172. Increased cost of maintenance. Cost of maintenance is a burden not upon the buyer but upon the public. A regulated public utility will be entitled to such rates as will pay proper returns over and above operating expenses in which are included costs of maintenance. As a matter of fact, in practically all cases, the property sold will possess units of widely differing ages. Under such conditions, especially if the property is increasing in size, the expense of maintenance as a percentage of the plant cost will be substantially uniform.

When these facts are considered there would seem to be no reason for diminishing the value of the plant for this reason. The buyer has the virtual promise of the public to pay the reasonable cost of maintaining the plant, whatever the cost of maintenance may be. Unreasonable cost of maintenance is cared for definitely in a proper determination of life (see section 120). The public does not suffer, as it will make no difference to it whether this expense of maintenance is paid to the new owner rather than to the original owner of the property.

173. Uncertainty as to life. Unquestionably there is

a certain amount of uncertainty as to whether the perishable property will last out the full life assigned to it as the basis upon which the loss of value due to age has been figured. There is always this uncertainty in making the annual reserves for depreciation, but this uncertainty would be greater with a new plant than it would be at the time of a sale, when the plant has served already a portion of its life.

Again, the probabilities are quite as great that the property can be retained in service longer than the assigned life rather than for a shorter period. In fact the probability is that, if anything, the estimated life will be less rather than greater than the actual life.

But, more than all the reasons above given, is the fact that the public pays rates sufficient to provide needed depreciation reserves, so that the risk to the purchaser of a public utility will be no greater, in most cases, than to the original owner or to any other owner of a public utility service.

174. Value of franchise. The commercial value, which was presented in cases involving rates as a figure of doubtful value as evidence due to the fact that it is based, necessarily, upon existing rates, the very quantity under investigation, becomes a figure of greater importance in a case of sale, as the question of rates is not directly at issue, and, in many cases, it may be a reasonable assumption that the rates prevailing under the management of the original owner may be continued unchanged under the new. Under certain circumstances, also, the value attaching to a franchise may be given a value which could not be included as a definite figure in a rate case.

175. Depreciation in cases of sale. The same line of reasoning holds as to depreciation in a case of sale as in that where the question of rates is involved. The public must be assured that there will be sufficient funds

in hand to make renewals of the perishable property when such renewals may be required. It is to be presumed that the undertaking has been making reserves to depreciation in the past. If it has not, it should have done so. Such reserves may have been invested in the plant or they may have been held in readily convertible securities. Probably it will make no difference, as far as the method of appraisal is concerned, as both the cash forming a portion of the working capital of the seller, and such reserves as have not been invested in the plant, will be retained by the seller. Theoretically, of course, these funds should be turned over with the remainder of the property paid for by the buyer, but as this may be only a transfer of money backward and forward between buyer and seller, it is usually not done.

176. Investment of buyer must be full cost-new of a public utility property. The condition peculiar to a sale of a public utility exists in the necessity of the buyer paying the full cost-new of the property, — that is to say, the present value of the perishable property plus its intangible property to which must be added such a sum in cash or securities as will guarantee to the public a continuation of the undertaking.

This requirement is so foreign to ordinary private sales that it must be explained at some length in order that its justice may be appreciated fully.

A private undertaking would pay the fair present or market value of a plant and that cost would be its invested capital. Upon this capital the owner might establish rates for service as high as if the purchased plant had been new, trusting to his profits to acquire sufficient funds to replace the plant when the proper time arrived.

A public service undertaking could not do this with fairness to the public, for the reason that, if a property was purchased for a fraction of its cost-new, the purchase