Opinion ID: 1224779
Heading Depth: 1
Heading Rank: 1

Heading: Fair Value Of The Properties

Text: In its application, General alleged that the net book cost of its properties used in intrastate service in North Carolina as of the end of the test period, 31 March 1970, was $33,467,015, which, together with its cash working capital and materials and supplies on hand, gave it a total net investment, as of that date, in the amount of $34,531,781. This includes plant under construction at the end of the test period and the amount eliminated by the Commission as excess plant margin. It alleged that the net trended cost of its properties, including the above mentioned items, was such as to give it a rate base as of the end of the test period of $43,480,850. The testimony and exhibits prepared and introduced by General's controller, Mr. Redman, are to the effect that the original cost of its intrastate plant in service at the end of the test period was $39,030,988 against which General has, through annual charges with Commission approval, accumulated a depreciation reserve in the total amount of $6,635,641, giving it an end of period net investment in plant of $32,395,347 (original cost less depreciation). This figure also includes plant under construction and the amount disallowed by the Commission as excess margin. [Thus, the accumulated depreciation reserve is approximately 17% of the original cost of the properties prior to any deductions for these items.] General's Witness McGrath testified that the trended cost of the properties, including plant under construction and the entire plant margin, as of the end of the test period, was $52,930,678 and the net trended cost thereof was $49,409,698. [The difference, $3,520,980, is this witness' allowance for depreciation, this being only 6.65% of his estimated trended cost of the properties.] Apparently, Mr. McGrath's figures relate to General's entire plant in North Carolina, including the portion attributable to interstate service, which if true, would require a substantial further reduction therefrom. His estimate of 6.65% depreciation was the result of his inspection of the plant and the exhibit prepared and introduced by him showed, among the several property accounts [i. e., types of property], he observed only pole lines to have depreciated as much as the 17% reflected in General's accumulated depreciation reserve. Mr. McGrath testified that his trended cost figure was intended by him to represent the fair value of General's properties. In this computation, he made no determination as to whether the plant in service was properly engineered. He testified, I trended what was on the books of the company    I don't know what the book reserve [for depreciation] is. I haven't had it.    I am out there telling the condition, physical condition of the plant as of today.    I am taking the original piece of equipment and replacing it, the same design, brick for brick, and value has nothing to do with potential buyers and sellers and value on the market. It is my understanding that it is replacing, and the fair value is set up for me to replace it as an Engineer. I cannot go out and re-engineer a plant. (Emphasis added.) In response to the question, Replacement is something that would render the same service using current technology which may produce a substantial different result than trending the existing plant to current cost? Mr. McGrath replied: I am not permitted to do that. That is not the value I am permitted to use. I would get a different value but I am not allowed to do it. [Thus, this witness' estimate of trended cost takes no account of obsolescence or of faulty engineering, but is his opinion as to the trended original cost of the properties actually in use, less his own estimate of physical depreciation only, with no deduction for the defects in service described by the 51 subscriber witnesses and found by the Commission, many of which would appear to be attributable to the condition of the equipment.] The Commission Staff offered the evidence of its Staff Engineer, Mr. Cash. He testified that General's density of 181 stations per square mile is the highest in the State and over four times that of the State average. From this circumstance he would normally expect General's investment in plant per telephone in service to be below the State average. However, General's investment in plant per station is $573.00, as compared with the State average of $526.00. He attributed General's greater investment per station, in large part, to General's crash program of construction in 1968 and 1969. In his opinion, this comparative investment per station is a fact which should be considered by the Commission in determining the fair value of General's properties. The Commission Staff's Chief Engineer, Mr. Clemmons, testified that service problems still exist in several areas of General's operations in North Carolina. He found only 7.16% of the pay stations checked were in operational condition. He further found that the failure rate for calls, inter-office and intra-office combined, was 2.74% and that the number of initial trouble reports per 100 stations was 8.5, whereas the figure should be in the rage of 6 per 100 stations. He testified: I would compare Durham [i. e., General] to Southern Bell in Raleigh, and Raleigh's Southern Bell is reported for the month of December, 1970 total subscriber trouble reports of 4.22 per 100 stations. For General    for December, 1970, initial trouble reports were 7.3 per 100 stations, Charlotte for the month of December 3.43, Greensboro 5.06. The Commission Staff Accountant, Mr. Peele, testified that General's investment in telephone plant in North Carolina increased $9,559,134 in the 16 months immediately prior to the test period used in this proceeding, and an additional $6,972,105 was added to its investment in plant during the test period. [This coincides with the period in which, according to Staff Engineer Cash, General was engaged in a crash program of construction, and coincides with the period in which Chief Engineer Clemmons found the company installed the central office equipment far in excess of a reasonable engineering interval.] G.S. § 62-133(b) requires the Commission to ascertain, that is, to find the fair value of the public utility's property used and useful in providing the service. In so doing, the statute requires the Commission to consider (1) the reasonable original cost, less depreciation, (2) the replacement cost, which may be determined by trending such reasonable depreciated cost to current cost levels or by any other reasonable method, and (3) any other relevant factor. Quite obviously, replacement cost and fair value are not synonymous. It is equally clear that fair value is not an arithmetical average of original cost and replacement cost, less depreciation, nor is it to be ascertained by the application of any mathematical formula. Conversely, a finding of fair value by the Commission is not rendered immune to judicial review by the Commission's declaration that, in reaching such finding, it followed no formula. The statute contemplates a considering or a weighing of the three factors by the Commission in the exercise of its own expert judgment. State ex rel. North Carolina Utilities Commission v. Westco Telephone Co., 266 N.C. 450, 454, 146 S.E. 2d 487; State ex rel. Utilities Commission v. Public Service Co., 257 N.C. 233, 237, 125 S.E.2d 457; State ex rel. Utilities Commission v. State (State ex rel. Utilities Commission v. Southern Bell Telephone & Telegraph Co.), 239 N.C. 333, 344, 349, 80 S.E.2d 133; Railroad Commission of State of California v. Pacific Gas & Electric Co., 302 U.S. 388, 398, 58 S.Ct. 334, 82 L. Ed. 319; Dayton Power & Light Co. v. Public Utilities Commission, 292 U.S. 290, 311, 54 S.Ct. 647, 78 L.Ed. 1267; Los Angeles Gas & Electric Corp. v. Railroad Commission, 289 U.S. 287, 53 S.Ct. 637, 644, 77 L.Ed. 1180; Minnesota Rate Cases (Simpson v. Shepard), 230 U.S. 352, 434, 33 S.Ct. 729, 57 L.Ed. 1511; New England Tel. & Tel. Co. v. Public Utilities Commission, 148 Me. 374, 94 A.2d 801; State v. Hampton Water Works Co., 91 N.H. 278, 18 A.2d 765; New York Telephone Co. v. Public Service Commission, 309 N.Y. 569, 132 N.E.2d 847; City of Pittsburgh v. Pennsylvania Public Utility Commission, 187 Pa.Super. 341, 144 A.2d 648. The determination of the weight to be given each of the above factors in its ascertainment of fair value is for the Commission, not the reviewing court. But if it is clear from the record that the Commission reached its finding of fair value by disregarding or giving minimal consideration to one of the above enumerated factors, its finding of the ultimate fact of fair value may be set aside by the court on the ground of error of law in such ascertainment. State ex rel. Utilities Commission v. Lee Telephone Co., 263 N.C. 702, 707, 140 S.E.2d 319; State ex rel. North Carolina Utilities Commission v. Piedmont Natural Gas Co., 254 N.C. 536, 119 S.E.2d 469. Similarly, the finding of fair value may be set aside by the reviewing court if it clearly appears that the Commission has made its determination thereof by giving weight to a factor as to which there is no substantial evidence in the record. State ex rel. Utilities Commission v. Carolina Coach Co., 261 N.C. 384, 134 S.E.2d 689. It is likewise where the order of the Commission shows that it reached its determination of fair value by considering unspecified facts other than original cost and replacement cost depreciated. State ex rel. Utilities Commission v. Public Service Co., 257 N.C. 233, 125 S. E.2d 457. The mere recital by the Commission that it has considered all of the factors prescribed by G.S. § 62-133 in arriving at its ascertainment of fair value does not preclude the court from setting aside the finding of fair value where the record discloses any of the above mentioned errors of law. State ex rel. Utilities Commission v. Public Service Co., supra. It seems inescapable that the Commission cannot consider or weigh an element until it first determines what that element, itself, is. No doubt, the Commission, in the present case, formed an opinion satisfactory to itself, as to the amount of the replacement cost, depreciated, of the properties included in its determination of the reasonable original cost, since it said it had given consideration thereto. Unfortunately, though it set forth its finding of the net investment [i. e., the reasonable original cost, less depreciation], it failed to set forth its finding of the replacement cost, depreciated. We do not construe this omission as an acceptance by the Commission of Mr. McGrath's conclusion, for, as we have indicated above, his conclusion was predicated, in substantial part, upon certain items the Commission excluded from net investment, and upon an erroneous treatment of depreciation. While the consideration or weight to be given replacement cost, depreciated, in ascertaining fair value rests in the sound discretion of the Commission, the reviewing court cannot satisfactorily determine whether the Commission considered or weighed this element at all, or merely gave it minimal consideration, unless the Commission sets forth what it found this element to be. Though perhaps not indispensable to the validity of such finding, it would be proper, and certainly helpful to the reviewing court and to the parties, for the Commission to state, at least in summary, its reasons for not acquiescing in the figures suggested for this element by the respective expert witnesses. Original cost, less depreciation, and replacement cost, less depreciation, are not ultimate facts but evidential facts only. The ultimate fact, in this segment of a rate case, is fair value. However, G.S. § 62-133 requires that these evidential facts be considered or weighed by the Commission in determining this ultimate fact. This is not to say that in no case may the Commission fix rates to be charged by a utility for its service without a determination of replacement cost, less depreciation. The utility, with the Commission's acquiescence, may offer evidence of original cost less depreciation, as its only evidence of fair value. Proof of replacement cost is exceedingly costly, and may be unduly burdensome, especially to a small utility company. However, where, as here, such evidence is introduced, the statute seems clearly to require that the Commission make, and set forth in its order, its findings as to both of these evidential facts, along with any other facts considered by it. G.S. § 62-79 requires that all orders of the Commission shall include findings upon all material issues of fact, law, or discretion presented in the record. State ex rel. Utilities Commission v. Haywood Electric Membership Corp., 260 N.C. 59, 64, 131 S.E. 2d 865; Smith v. Illinois Bell Telephone Co., 282 U.S. 133, 152, 51 S.Ct. 65, 75 L. Ed. 255; Northern States Power Co. v. Board of Railroad Commissioners, 71 N.D. 1, 298 N.W. 423; Commonwealth Telephone Co. v. Public Service Commission, 252 Wis. 481, 32 N.W.2d 247. We hold, therefore, that, when the record before the Commission presents the questions of the original cost, less depreciation, and the replacement cost, less depreciation, these are material issues of fact, upon each of which the Commission must make its finding. When it does so, those findings are conclusive, if supported by substantial evidence in the record and not affected by an error of law. Having made such findings, so supported, it is for the Commission, not the reviewing court, to determine, in its expert discretion and by the use of balanced scales, the relative weights to be given these several factors in ascertaining the ultimate fact of fair value. State ex rel. North Carolina Utilities Commission v. Piedmont Natural Gas Co., 254 N.C. 536, 550, 119 S.E.2d 469. It is, of course, the prerogative of the Commission to determine the credibility of evidence, even though it be uncontradicted. It is clearly the prerogative of the Commission to take into account, in making its finding of replacement cost, errors or omissions in the testimony of an expert witness purporting to show such replacement cost. It must be borne in mind that the ultimate fact to be found is the present fair value of the properties. Obviously, the present fair value of a plant, physically new, but composed of outmoded, obsolete equipment, poorly designed and engineered, cannot exceed what it would cost to build today a modern, well engineered and designed plant capable of producing the same quantity of service at lower operational costs. See the dissenting opinion of Justice Brandeis, concurred in by Justices Holmes and Stone, in St. Louis & O'Fallon Railway Co. v. United States, 279 U.S. 461, 488, 517, 49 S.Ct. 384, 73 L.Ed. 798, and the authorities there cited. Consequently, the Commission is not required to accept as a factor to be weighed, in determining fair value, the full amount stated by an expert witness to be the cost of reproducing the exact plant now in operation, brick for brick, pole for pole, and wire for wire. It is obvious that consistently poor service, attributable to defective or inadequate or poorly designed equipment or construction, justifies a subtraction from both the original cost and the reproduction cost of the existing plant before weighing these factors in ascertaining the present fair value of the properties. City of Alton v. Commerce Commission, 19 Ill.2d 76, 165 N.E.2d 513, 518. The Commission must, however, make a specific finding showing the effect it gave this relevant factor, if it made such deduction on that account. State ex rel. Utilities Commission v. Morgan, Attorney General, supra, 277 N.C. at pp. 268-269, 177 S.E.2d 405. As the Supreme Court of Appeals of Virginia said, in Alexandria Water Co. v. City Council of Alexandria, 163 Va. 512, 563, 177 S.E. 454, 476: The fact that a plant or a unit thereof is not well adapted to, or is inappropriate for, its present and/or reasonably to be anticipated future use tends materially to reduce its value below its reproduction new cost. One of the forms of inappropriateness is inappropriate engineering layout. G.S. § 62-133 recognizes the self-evident truth that the present fair value of a utility plant, which includes properties installed at varying times over a period of many years, is not to be ascertained by simply weighing the original cost new and the replacement cost new. From each of these there must be subtracted an appropriate allowance for depreciation in order to reach the elements which are to be considered in arriving at the ultimate fact of present fair value. In this era of automation and a well nigh constant flow of inventions and new techniques, the art of telephony is rapidly changing. Obsolescence often takes a heavier toll from the value of plant and equipment than does physical wear and tear. Before there is any return whatever to the utility upon the fair value of its properties, it must recover its operating expenses, including an adequate allowance for the depreciation or consumption of its properties in the public service. State ex rel. Utilities Commission v. Morgan, Attorney General, supra, 277 N.C. at p. 262, 177 S.E.2d 405. Rates for service are fixed by the Commission on the basis of including, as an operating expense, an annual charge for depreciation, which over the anticipated useful life of the property will, upon its retirement from service, be sufficient in amount to restore to the utility the full original cost of the property. G.S. § 62-35; State ex rel. Utilities Commission v. State (State ex rel. Utilities Commission v. Southern Bell Telephone & Telegraph Co.), supra, 239 N.C. at p. 346, 80 S.E.2d 133. The Commission is expressly authorized to prescribe what are proper and adequate charges for depreciation of the several classes of property for each public utility, and to make such changes from time to time in these as it finds necessary. G.S. § 62-35(c). General's charges to operating expenses for depreciation, so approved by the Commission, are computed on the straight line basis, the most frequently used of several methods for computing annual depreciation charges. Substantially, this method involves (1) estimating the service life of the various properties included in the plant, (2) estimating the salvage value of such property at the end of its useful service life, (3) dividing the original cost of the property, less its salvage value, by the number of years of its anticipated service life, and (4) charging annually to operating costs, and setting aside in a reserve for depreciation, an amount equal to such quotient. The reserve so created is customarily reinvested in the business. If these estimates and computations are correct, at any given time during the service life of the property, the reserve will be in the same proportion to the original cost as the consumed portion of the property is to the total property new. Obviously, as to any specific item of property, this exact relation of accumulated reserve to accumulated actual depreciation at any given time is unlikely, since properties do not wear out or become obsolete at a uniform rate. Nevertheless, when this method is applied to the innumerable items constituting a utility plant, these having been installed in service at varying times over a period of years, a reasonably close relationship between the reserve and the actual accumulated depreciation is probable. If such relationship is not present, then the Commission, in fairness both to the utility and to its ratepayers, may and should review, and make appropriate changes in, the annual charge to operating expenses on account of depreciation. In State v. Hampton Water Works Co., 91 N.H. 278, 18 A.2d 765, 774, the Supreme Court of New Hampshire, speaking through Chief Justice Allen, said: It would seem that the company's actual depreciation reserve, found by the commission to be adequate and proper, should be applied in proportion to reproduction costs. See also: Tobacco River Power Co. v. Public Service Commission, 109 Mont. 521, 98 P.2d 886; City of Philadelphia v. Pennsylvania Public Utility Commission, 174 Pa.Super. 641, 102 A.2d 428.