Central States Water Works Convention
GENERAL NEWS ARTICLES
Conclusion of the Proceedings, Including Paper Read by Philip Burgess on “Engineering Appraisements of Water Works Properties,” Followed by Lengthy Discussion—Address on “Municipal Ownership,” by Hon. W. J. Springborn, Cleveland
Herewith is presented the remainder of the proceedings of the Central States Water Works Association convention held at Breakers’ Hotel, tedar Point on Lake Erie, O., on August 26. On Wednesday morning the principal business was the reading of a paper entitled Some Features of Engineering Appraisements of Water Works Properties,” by Philip Burgess, member of the American Society of Civil Engineers of Columbus, O., followed by a lengthy discussion. Following is a copy of the paper:
Appraisements of Water Works Properties
Last year the speaker had the pleasure of presenting a paper to this Society on the question of water rates, and at that time it was endeavored to show that agitation for adjustment of rates charged for services furnished by municipal water supplies is generally brought about by poor service rendered. Subsequently this contention has been brought forcibly to the attention of the speaker in two problems of readjustment of water rates, the one at Chillicothe, Ohio, and the other at 1 exarkana, Arkansas, and Texas. The Chillicothe case was the tirst water rate case tried before the Ohio Public Service Commission, and was brought about principally because the water company refused to give proper tire service to residence on Carlisle Hill, a comparatively new section of the city, in which is located the distribution reservoir of the water company. The city Council passed an ordinance stating that no payment whatever would be made for any hydrant, umess the minimum pressure at all hydrants was 43 pounds. The water company appealed to the Public Service Commission making this feature one of the several causes of complaint.
The question of adjustment of rates of Texarkana was brought up partly because there were occasional objections to the quality of the public water supply, on account of disagreeable odors and because it was believed that the water company at times used polluted creek water as a source of supply. On account of the features mentioned above, in both instances, the city authorities have taken measures to revise the contracts with the water companies. The problems have required appraisements of the local water properties, and the speaker has in both instances been retained by the city authorities to make the necessary valuations, it is hoped that some of the features brought out in these appraisements may interest this Association. It is generally understood that there are four principal methods which have been recognized as giving an indication of the true value of water works properties, as follows:
True Value of Water Plants
First: A determination of the original or book cost as indicated by actual past investments without allowances for depreciation or appreciations. To the value so determined, for comparative purposes, frequently there should be added the deficits in revenues below all necessary charges incurred during the early history of the plant.
Second: A determination of the probable cost of reproducing new the existing property at costs based upon present nominal prices for material and labor. Such a valuation properly must be corrected for depreciation resulting from the age and use of the plant. A determination of the value by this method includes studies of all values which may properly effect the worth of the plant as a going concern.
Third: A determination of the value of the plant as indicated by. the market value of its securities, especially when there exists a representative market of such securities.
Fourth: A determination of the commercial or comparative value of the plant. Such a value properly would be considered by a tentative investor, especially if he were without detailed knowledge of construction costs. He might very well have a general knowledge of the costs of water works plants, and would make a close study of the property in question relative to the growth and prospects of the community. Such a method, of course, is more commercial than scientific but affords information as to the value of the results obtained by other methods.
While it is perhaps true that the cost of reproduction new, properly depreciated, furnishes the best evidence of the present value of a water works utility, and while it is true that the laws of some states require the use of this method, it is believed that all available methods should be used and all facts considered which may indicate the true value of a water works plant either for purchase or for rate making purposes. Unfortunately the post or books costs of water works properties frequently are not available in reliable form, because the books are not properly kept, especially as regards replacements and extensions. It is not at all uncommon to find no plant account carried on the books and to find no distinction made between maintenance and depredation, or between maintenance and true operating costs. It is the exception to find a water works account in which depreciation is properly cared for. Consequently the engineer, in studying the book or past cost account, frequently is unable to arrive at even a reasonable conclusion as to the true past cost of the plant.
The Securities Market
Moreover, it is the exception to find a representative market of the securities of water works properties. In the majority of instances where plants have been established for a number of years, the face value of the securities has little if any relation to the cost of the plant, so that it is an unusual instance when this method of appraisement is of very great value. Considerable data are available as to the results of appraisements of water works properties by engineers, who, in the event that they are interested in such matters, keep in their files or libraries, books which contain such values as are published from time to time. Such appraisements are of considerable worth when they are of properties located where conditions of labor and prices of materials and where construction features are similar to those under consideration in making a particular valuation. Frequently, however, such data as to local conditions are not contained in published reports, so that often published valuations are of little comparative worth. On account of the unreliability of other methods of valuation, and on account of the fact that, frequently, laws require appraisements to be made as of the cost of reproduction new, the latter method is the one most frequently used in determining the valuation of water works properties. It is obvious that the method of reproduction new involves many difficulties, because the appraisement entails working from small to very large units composed of many items, the cost of which must be determined in accordance with the best judgment of the engineer, in view of the necessity of working from small to large items any one of which is subject to error, it is apparent that the final result may be far from the correct one. Hence arises the value of the other methods discussed above, when available, especially to confirm the result obtained by the method of reproduction new. However, from the detailed estimate and studies required of the engineer under the latter method, there is apparent a distinct advantage due to the necessarily careful and comprehensive study of local prices and conditions under which the work must be constructed. Such studies, of course, require of the appraiser that he must consider all available facts rather than merely his general exnerience.
Getting at the Value
As previously stated, the cost of reproduction new must be properly depreciated to determine the present worth of the plant. This also requires of the appraiser that he study carefully the life, age, and present condition of the various component parts of the properties, and must, moreover, determine the average life and rate of depreciation of the entire plant as a whole. Subsequently, he may properly assist or confirm his judgment in determining the depreciation and present worth of the plant in question by considering general data available on the lite and depreciation of similar structures published in tables prepared by authors of experience in making utility appraisements. It is obvious that rare judgment and experience are required of the engineer in using such comparative date, because no two plants are composed of the same component parts, and because the proportions of equally depreciable parts vary in different plants. In applying the method of reproduction new to the appraisement of a particular property, it is necessary to assume the beginning of the construction of a comparative plant under the data of the appraisement. It is also obviously necessary to assume that such construction shall be carried forward in a manner humanly possible. From the very nature of the method, it is apparent that the unit prices assumed by the engineer in constructing his imaginative comparative plant, are a very important element of the final result obtained. It is a well known fact that a water works plant is composed of many widely differing component parts, the cost of some of which vary materially from time to time while the costs of other parts are more constant. A large element comprising a water plant is the cast iron pipe and trenches. The cost of the pipe varies with supply and demand, and with the cost of pig iron. The cost of the trenches varies with the depth required for protection of the pipes, with the cost of common labor, and with the character of the material excavated. Such other elements as valves, hydrants, pumps, boilers, etc., are of more uniform cost, so that generally accurate cost data of such materials arc at hand for comparative purposes. Considerable experience and judgment are required of the engineer in arriving at a fair estimate of the cost of reproducing the cast iron pipes. It is customary to base the cost of reproduction on past costs for a period of five years preceding the date of valuation. It may be of interest to note the costs of pipe as testified by the several engineers retained in the Chillicothe case. The speaker, for the city, took up the matter with the United States Cast Iron Pipe and Foundry Co., and learned that quotations of cast iron pipe at Chicago as given in “Iron Age” contain an allowance of about $2.00 per ton for freight from Addyston, Ohio, to Chicago, Ill. The estimate cost of cast iron pipe at Chillicothe, therefore, was obtained by determining the average cost of pipe for the last five years as quoted in “Iron Age” and by correcting this average price by a proper allowance for freight from Addyston to Chillicothe. This matter, of course, was of considerable interest to the members of the Commission, who called in the manager of the local plant of the U. S. Cast Iron Pipe and Foundry Co. to testify as to actual past costs of pipe. It was brought out in his testimony that the cost of pipe is more or less indeterminate and depends upon the stock on hand in the various foundries and on the desire for business as determined by market conditions. Consequently it is difficult to estimate the cost of a large lot of pipe such as may be required for the reproduction of a water system. It was also shown that past costs of pipe, as required for extensions made from time to time, have little value in determining the cost of reproducing new, because frequently such pipes are bought in small lots and not at carload prices. In the following table are shown the estimated reproduction costs of pipe per ton at Chillicothe as given in the testimony of the engineers.
Estimated Cost of Replacing Cast Iron Pipe at Chillicothe
*50 cts. per ton added to figures in these columns to cover cartage.
Little difficulty generally is encountered in determining the cost of labor in a community. In the Chillicothe case, however, it was argued that a large piece of work like the reproduction of the local water plant would cause a scarcity of local labor so that it would be necessary to figure on imported labor at higher cost than local labor. This assumption naturally led to the question of digging the pipe line trenches by machine, a method which is more economical than hand labor on large pieces of work. There was also discussed the question of the practicability of such construction in the streets and especially in those which were occupied by street-car lines. These features are cited simply to illustrate the fact that the reproduction new must be by a method humanly possible, as before mentioned, and also to indicate some of the problems which the engineer must consider in using his proper judgment as to the determination of proper unit costs. They refer strictly to the reproduction of the physical plant. It is, of course, true that preliminary costs such as interest during construction, engineering, supervision, and contingencies must be included and they are generally estimated as a certain percentage of the total cost of reproducing new the physical plant. Such costs frequently are estimated at from 10 to 15 per cent. They should, of course, be determined upon the total cost of reproduction new and not upon the present worth after allowing for depreciation, although the latter method was used by one of the engineers employed in the Chillicothe case. Having determined the total cost of reproduction new, including preliminary costs, the next feature is to determine the proper allowance for deprcc ation. I icre again widely differing results may be obtained by several engineers employed on the same appraisement. It is well established that a determination of the proper allowance for depreciation of a water plant requires that there be made an estimate of the probable life of the component parts of the plant. From the costs and probable life of the component parts, there may readily be determined the average life of the entire plant as a whole. The depreciation fund properly should represent at all times as closely as possible the difference between the investment and present worth of the plant. Moreover, the annual contribution to the depreciation fund placed at compound interest, should be of an amount such that the depreciation fund accumulated during the period of the life of the plant as above estimated will equal the cost of the plant. It is apparent, therefore, that an important element to be considered by the engineer in determining the amount to be contributed annually to the depreciation fund is the rate of interest which such fund may properly be considered to yield. It was argued in the Chillicothe case that such funds in the past had been used for extensions and that, therefore, the rate of interest on the depreciation fund should be considered as that allowed for a fair return on the entire investment. If, however, the depreciation fund is to remain intact, a savings bank rate of interest at from 3 to 4 per cent, may properly be considered as fair. As a matter of interest and showing the difference in the opinions of the appraisers of the Chillicothe plant, S. S. Weyer and J. N. Chester for the company estimated depreciation at the rate of 1 per cent annually; J. W. Alvord, also for the company, an dthe speaker, for the city, at ¾ per cent annually. 1 he speaker computed the average life of the plant at 50.8 years and assumed a rate of interest of 3.5 per cent, compounded annually.
What Constitutes a “Going” Plant
It may be of interest here to recall the attention of the members of this Association to the excellent paper presented last year by Mr. Erickson, Chairman of the Wisconsin Railroad Commission, in which he shows that the average per cent, condit.on, that is the ratio between cost of reproduction new and the present worth of 23 water works plants, as determined by the engineers of the Wisconsin Commission, was 91.0 per cent. The maximum was 94.6 per cent, and the minimum was 84.6 per cent. Having determined the present worth of the plant, by the methods outlined above, the next question to be decided by the engineer is what additions proper ly may be included to give the entire valuation of the works as a going concern. Herein again it will be found, as at Chillicothe, that there is a considerable difference of opinion among engineers as to the method of estimating what is commonly called the going concern value of a water works plant. While the courts have determined that a water plant has a value in addition of its “present worth,” unfortunately, they have not determined how such a value shall be estimated. They have left this for the engineer to determine. In the following discussion three of the methods sometimes used to determine going value will be outlined briefly. The first method is to figure going value as equal to the past cost of developing the income of the present plant during its early history. The books of the water company, where available, generally indicate deficits during the first few years’ operation of the plant. Such deficits between the revenue and total costs of operation, including allowances for interest and depreciation, may very properly be called “development cost” as distinct from “going value.” For comparative purposes the development cost should be included in the book cost of the plant. It properly has no relation to the cost of reproduction new, although sometimes has been included by engineers. The estimate of cost of reproduction new arrived to a logical conclusion brings one to the second method of estimating “going value”; namely, as the cost of developing the income of an imaginative comparative plant exactly like that in question; the construction of the comparative plant to begin on the data of appraisement. This requires one to consider present rather than past conditions.
Value of the Physical Plant
A third method of computation has been indicated by the courts to be a measure of the added value of the physical plant due to the fact that it is a going and not a dead concern. This would seem to be on the basis that the “present worth” of the physical plant may be considered greater than that obtained from the cost of reproduction new corrected for the usual allowance of physical depreciation, and that the present value of the plant is more nearly that of the cost of reproduction new. In other words, it is recognized that the physical plant may have a value to the company greater than its depreciated reproduction cost, because the plant may be just as capable of giving first-class service to the public as it would be if it were absolutely new. This theory has been carried as far by some engineers as to lead them to say that the value of a plant for rate making is the cost of reproduction new, and not the present worth as obtained by making allowances for depreciation, and adding thereto a certain amount to represent the going concern value estimated as a separate distinct item. The three methods of estimating the increment of value due to the fact that a plant is a going concern, as outlined above, have all been discussed many times in engineering publications, and all were argued in the Chillicothe case. They differ widely in principal and frequently, also, in the results obtained. It is apparent that there is bound to be much difference of opinion and considerable variance in engineering appraisements until this matter may have been properly threshed out and a deciding opinion obtained from the courts instructing engineers definitely how this element of value shall be determined. In view of the greatly differing methods of approaching the appraisements of water works properties, it is not very remarkable that published results of such appraisements have but little value for comparative purposes unless accompanied by considerable detailed description relative to the manner of procedure in making the valuations and as to local conditions. Such costs may properly be compared on the basis of (1) cost per consumer, (2) cost per foot of mains, and (3) cost per ton of cast iron pipe mains. Cost date relative to these features, for comparative purposes, should be reduced to a common basis of average length of cast iron mains per consumer. The following average costs of six small water plants as given in Volume 4, Reports of Wisconsin Railroad Commission, page 285, may be of some interest and value; (l) Cost of consumer, $162.88. (2) Cost per foot of mains, $1,841. (3) Average length of mains, per consumer, 90.1 ft. In us.ng these costs for comparative purposes, it should be noted that they are based on Wisconsin conditions where trenches are about six feet deep; also, in part, on costs of cast iron pipe during the years 1906-1907 when pipe was selling for around $35 per ton. In the report of the appraisement of the water plant at Freeport, 111., (Ref. Engineering & Contracting; Vol. 38, Page 368j are shown the following data relative to the average value of the water works properties of twenty-seven cities, of population varying from 4,000 to 40,000.