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An Extension of Price Theory.-Value theory has for the most part concentrated upon the nature of market value. Commodities bought and sold in markets have been the chief subject of analysis. When the values of capital equipment or other objects not in the market have been considered, they have been treated under the head of derived value. Other than market values have been disposed of as values derived from the market values. This inclusion of everything within the scope of market values and the incidental derived values has resulted in a logical and symmetrical system of thought.

But in the modern money economy, it is necessary to supplement these abstract value principles with more definite considerations. Valuation has broadened to include many things not originally contemplated by the masters of thought who formulated traditional economia theory. Valuation should be considered no as a relative term, that is, relative to some specific purpose. If the purpose is rate making for public utilities, valuation involves a peculiar technique which does not apply to any other situation. If the purpose is taxation, appraisal of value has a method unique for that purpose. If the purpose is making complete accountant's records of a concern, valuation proceeds upon certain lines distinctive for that one purpose. If the purpose is investment in property, or appraisal of the security behind loans, or government price fixing for articles of consumption, value is a special matter peculiar to the single purpose in hand. Value as such has little meaning. Value for a specific purpose alone has meaning. Some of the purposes of valuation will be briefly considered.

Valuation of Corporate Securities for Purposes of Investment or Speculation. The elements of value in the market for stocks and bonds are many and varied. To suggest the character of such elements, it is desirable to present certain of the more important factors governing the prices of corporate securities. When a person buys a security, the thing really bought is a right to income. The interest or dividend paid by the security is the objective of the buyer. In addition to this, he may desire to speculate on an appreciation in value of the security, but such speculation will in turn depend upon some other buyer's desire to obtain the income which the securities yield. In other words, demand for corporate securities is a demand for the incomes which they yield, and supply is supply of incomes which they yield. The upper

most question in the buyer's mind is how much he can afford to pay for the right to a certain dividend or interest payment.

Since the real objects purchased are rights to income, primary importance attaches to the question of the ability of the corporation to earn an income. Earning power of the corporation is the source and fountain of dividends and interest payments on stocks and bonds. The earning power in question is not merely for the present but for the future. The buyer is anticipating what earnings are likely to be. Future earning capacity is just as important as present earning capacity.

Earning capacity, both present and future, is translated into value by the process of capitalizing incomes. An income of $600,000, capitalized at the rate of 6 per cent, gives a value of $10,000,000. Capitalized value is determined by dividing a given rate per cent into the amount of income. Any variation in either the size of the income or the rate of capitalization yields a different capitalized value.

Capitalization of earning capacity is fundamental to all valuation of corporate property. The capitalization process underlies all estimates of investors or speculators.

The estimate of earning capacity involves a further concept, which may be stated as the value of the going concern. The value of the going concern rests upon tangible and intangible values. The tangible values are the values of the physical plant merely as commodities. Brick and mortar, structural steel, lumber in the plant, all have a price in the commodity markets, and the factory from which they are made has a physical value which is related to this value. Each machine has a value as a machine, a physical value. But the sum total of these physical values is less than the whole value of the corporate property. In excess of the merely tangible values are intangible values. The intangible values reflect the capacity of the business to earn money. If a concern decided to scrap its plant, and sell the separate pieces of matter for their scrap value, the selling price would be low indeed. But when the scattered mass of material is fused into a business organization, it has a new value, and a greater value. This added value arises from varied sources. The efficiency and reputation of the management, the possession of a favorable location, the ownership of patents, copyrights, secret processes, and franchises, the morale and esprit de corps of the labor forces, the creation of fixed buying habits through advertising, the existence of an effective sales organization, the building of strong credit relations with the banks,—all of these factors combine to augment the value of the established business as a going concern. These factors one and all increase the good will of the organization. In 1925, an automobile company which sold for $146,000,000 included as a part of the purchase price good will valued at $50,000,000. This value as a going concern is highly perishable and

1 For further analysis, see below, pp. 228-230.

very difficult to reproduce. If the plant burns up, a new one can be erected in a brief time. But if the going concern is destroyed, it will require years to re-create good will and all the advantages and privileges that go therewith.

This value, although intangible and immaterial, nevertheless is of vital importance in determining the capitalized value of a corporate business. It is important because it represents the capacity of the business to earn extraordinary profits. Going concern value is in proportion to the earning capacity of the business. Good will value is in proportion to the ability to earn excess profits. Earning capacity is the acid test of the proper weight to be given to these intangible assets. This earning capacity, in turn, is the income which is used in determining the capitalized value of the corporation. The market value of its securities will depend closely upon the earning power, as derived from both its tangible and intangible assets.

Although the central factor in the value of corporate securities is the capitalization of expected income, nevertheless this factor is surrounded by many conditioning factors. A partial list of these conditioning influences would include the following: (1) safety of the principal sum; (2) regularity of dividend and interest payments; (3) stability of the market price; (4) marketability of the securities; (5) taxation or tax exemption of the securities; (6) legality of the issue. Each of these items may be minutely studied in special books dealing with finance, but for purposes of the present volume, space permits merely to mention them as important factors conditioning the value of corporation securities.

This brief statement of the problem of investment values is necessarily incomplete. The purpose is to suggest the scope and nature of the problem, and to include it in the jurisdiction of value theory. Further refinement of the theory of investment values is offered in later chapters of the present work.3

2 Valuation of securities involves also a mathematical technique. Market price usually differs from par value. Interest is computed on

a par value, but this computation must be adjusted further to find what percentage it is of market value. The capitalization process refers to net yields calculated in this way, rather than to nominal rates on par values.

If a bond is kept until maturity, market fluctuations in the meantime have no significance for the holder. But if the owner wishes to sell before maturity, the price is a mathematical calculation drawn from the following main elements:

1. The current rate of interest on given grades of investments.
2. The redemption price of the bond.
3. The nominal rate of interest specified in the bond.
4. The frequency of interest payments.
5. The number of years to the redemption date.

From these elements, it is possible to calculate proper adjustments in bond values, taking into account the discount or premium on the bonds. Proper allowance for amortization can thus be made.

Of like importance is the calculation of actuarial data, of annuities and present values of future sums. The mathematical technique of investment finance is essential to valuation of financial items. For presentation of this technique, see F. C. Kent, Mathematical Principles of Finance, especially Chapter VI.

3 See Chapters XIII, XVII.

Valuation of Public Utilities for Purposes of Rate-making.–Those industries classed as public utilities afford a special problem in valuation. Telephone, telegraph, light, gas, and railway corporations have their rates regulated by public service commissions. Regulation has superseded competition. In these fields of enterprise, competition has for the most part broken down. It has failed to accomplish its function. The function of competition is to drive prices continually down close to the level of costs. Competition checks excess prices, and tends to make market prices equal normal prices. But in the public utilities, this function of competition has proved weak. Public utilities are monopolistic in their nature. Some are monopolies of location. For instance, a railroad may obtain exclusive control of the one best route, a telephone company must have exclusive control of service in order to make complete and universal connections for telephone users. Monopolies of organization are common. Where it is cheaper per unit of service to have large scale enterprise and monopoly control, competition breaks down. This consequence is common in those industries which fall within the law of decreasing unit costs with increasing volume of business. Monopolies of legal origin, due to franchises and exclusive concessions, also appear. In all such cases, competition as an effective weapon for the prevention of excessive prices is futile. The alternative is regulation of rates by public service commissions

Regulation of rates involves a determination of values. Fair rates are those rates which will yield a fair return on a fair valuation. Rate making leads back to value making. Public service commissions cannot fix rates without first fixing the values of the properties of the utilities concerned. The formula, “a fair return on a fair value," has made valuation for rate making purposes the pivot on which the whole structure of rates swings.

Valuation for rate making purposes differs radically from valuation of private industrial properties for investment purposes. In the case of industrial corporations, valuation centers chiefly around the capitalization of earnings. In the case of public utility corporations, valuation cannot take capitalization of earnings as its center without running in a vicious circle. Fair earnings are the unknown quantity, the sum to be found. But if existing earnings be capitalized, and such capitalized value be taken as fair value, then the existing earnings are arbitrarily assumed to be fair earnings. We should be assuming the fairness of the earnings, when this point is the very point in question. It should be obvious that any earnings would be fair earnings, if the valuation upon which they were based were their own capitalized value. To escape this vicious circle, it is necessary to step outside the technique of capitalization of earnings in order to find value for rate making purposes.

However, when a new and independent basis of valuation is sought, the result is not a matter of uniformity and agreement. For the most part, valuation for rate making purposes is a legal invention.

service commissions have endeavored to hand down rulings on the subject. State and federal courts have rendered countless decisions in individual cases. Statutory legislation has often attempted to clarify the procedure. By a process of accretion, these multitudinous rulings and decisions have developed into a body of principles of valuation. This body of principles is by no means unanimously subscribed to. is not even free from ambiguity in many of its implications. But in spite of these limitations, it is a substantial core of principles which can be codified and recognized.

The main interest of the courts in this particular problem of valuation has arisen from their obligation to protect property rights from confiscation without due process of law. The value of which the courts speak is the value which is protected from confiscation by state or federal constitutions. Legal value is reasonable value. Reasonableness is a compromise between two things,—reasonable prices to the public for service, and reasonable rewards to the corporations. Corporations cannot sustain rates so high that they constitute an unreasonable charge upon the public. The public cannot exact rates so low that they constitute an unreasonable impairment of the value of the corporation.

In stating the principles of reasonable value, the courts have left matters in a loose and vague form. This much is established, that cer. tain standard factors must be taken into account. Just how much weight must be given to them is largely left to the judgment of the commission or the court in each separate case. We may proceed to examine briefly some of the factors which must be taken into account in determining reasonable or fair value.

One factor of major importance is original cost. This figure is often difficult to ascertain, owing to the destruction or incompleteness of records, or to the fact that property has changed hands, gone through receivership, or become part of a consolidation. A further difficulty is in deciding upon what standard shall be taken for defining original cost. The standard may be actual original investment, but many authorities insist that the standard should be merely prudent investment. Prudence is intended to eliminate alleged values due to manipulations, speculation and the like. Additional confusion has arisen from the date to which original cost applies. Shall it include merely cost at the formation of the enterprise, or also subsequent betterments and additions? For the most part, it includes the betterments, and is original cost-to-date. In estimating this sum, much depends upon the accounting system and records of the corporation concerned. Even after original cost-to-date has been ascertained, that figure cannot be taken alone as the fair value. It simply is one essential step in arriving at fair value. It is not the final step, it is not the only step, it is merely one indispensable step.

A second factor of major importance is cost of reproducing the property of the corporation, at present prices. This figure is necessarily an estimate or a guess. It will vary greatly with the major

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