Opinion ID: 1362962
Heading Depth: 1
Heading Rank: 1

Heading: Valuation Technique.

Text: The basis for defendant's change in assessment values from that asserted in its opinions and orders to that argued before the tax court was a change in valuation methods utilized by defendant. In the original appraisal defendant used a composite weighted average of three indicators of value, the cost of plant weighted at 60 percent, the capitalized income weighted at 30 percent, and the market value of the company's outstanding stock and debt, or value of its outstanding issues of stock, bonds and short-term debt as of the assessment date, weighted at 10 percent. In its new approach presented to the tax court defendant chose to rely solely upon the capitalized income approach to fixing value. Plaintiff argues that all three indicators of value should be used here. ORS 308.205 provides that true cash value means the market value of the property as of the assessment date. The Department of Revenue's rule OAR 150-308.205-(A) 2 provides: Methods and Procedures for Determining True Cash Value: Real property shall be valued through the market data approach, cost approach and income approach. Any one of the three approaches to value, or all of them, or a combination of approaches, may finally be used by the appraiser in making an estimate of market value, depending upon the circumstances. [2] While, under the statute and rule, it is allowable for defendant to use only one approach in valuing property, whether in any given assessment one approach should be used exclusive of the others or is preferable to another or to a combination of approaches is a question of fact to be determined by the court upon the record. The income approach is now viewed as the most reliable indicator of value by both parties. They disagree, however, as to whether it should be the sole indicator of value and as to how income is thereby actually to be computed. As for the cost approach, defendant argues that it should not be used here because it sets the floor of value and thus finds less than the true cash value of the property. In virtually sole support of this argument defendant points to its attempted impeachment in the tax court of witness Ring, one of plaintiff's review appraisers, [3] by a portion of an article written by him in the National Tax Journal, Vol. XXV, No. 2, June 1972, at 236. On cross-examination Dr. Ring read from the article and testified: `In a regulated utility where income is limited to a stipulated rate of return as applied to a rate base reflecting original cost, better known as aboriginal cost in industry literature, less accrued depreciation, the order of evidence of value are [sic] reversed as original cost less accrued depreciation from all causes sets the floor of value and income adjusted to reflect hopefully a market rate of earnings sets the upper level of value.' I would subscribe to that. When I said [in the witness' earlier testimony] cost is the upper limits of value this is the traditional concept as expressed in my text which is written for unregulated companies. However, later in the tax court proceeding Dr. Ring described the background of the article and testified that cost sets the ceiling of value for regulated utilities: Well, that  at that particular time the market was extremely high when regulated  regulated  regulated bodies and Department of Revenues were using a high percentage rate applicable to stock and debt. At that time, too, in this particular company that I represented, the income generated was in excess of that allowed by the regulatory authority and a refund to customers was ordered, millions of dollars. So in that instance, the income generated was in excess of what the Public Utility Commission allowed. Therefore, income exceeded cost and the market exceeded cost and therefore I made that statement that under those circumstances the cost of  original cost would set the floor, but those were circumstances which are not present today. The market is not what it was then and neither  he would deal with the utility that earns in excess. It doesn't even reach the rate of capitalization. Though defendant did assert that Dr. Ring's testimony is contradictory, defendant did not rebut the reasoning of Dr. Ring's explanation. Mr. Goodman, another review appraiser for plaintiff, also testified that cost sets the ceiling of value: Q Now, would you say that  that there is a ceiling that we can look to for the true cash value of a regulated company, public utility? A Yes, I think this is where any appraiser would start as he moves into an appraisal. He would look at the nature of the operation to determine if he can get any broad bench marks to start with and in looking at a utility from the point of view of appraising its true cash value, he would, I think, immediately come to the conclusion that the cost approach to value would set the upper limit of the value and the reason that this would be is because of the effects of regulation. For instance, the income that can be generated from the property is a function, in effect, of the cost approach. Basically the original cost depreciated, or the rate base, with some minor adjustments in there. This then fixes an amount of income. If the rate of return that is authorized by the regulatory body is less than that required by a prudent investor, as it almost always is, the cost indicator then, obviously, has to set the upper limit of value.    Plaintiff asserts that the cost approach sets the ceiling of value because the original cost of plaintiff's utility assets, less accrued depreciation, serves as the base upon which the company's earnings are determined, and that because the evidence shows the company's allowed rate of earnings is less than the market rate of the cost of capital, the true cash value is less than historical cost. It is also noteworthy that in defendant's original appraisal and in plaintiff's review appraisals the cost indicator of value is higher than the other indicators of value. Absent effective rebuttal of plaintiff's position, we accept that cost sets the ceiling of value in this case. Beyond the floor/ceiling argument, there is testimony in the record of defendant's witnesses supporting use of the cost approach. At the beginning of the tax court proceeding, when they were being questioned about their original appraisal and before they had introduced the new appraisal using only the income method, defendant's witnesses asserted that the cost approach was more accurate than the income and stock and debt approaches. Mr. Bredehoeft, defendant's supervisor of the utility section of the valuation division, testified that the failure of Consolidated Edison Company of New York to pay its dividend in 1974 had a very depressing effect on the price of stock and an elevating effect on the `cap' rate or apparent cost of equity money during the two years at issue here. Because of its lowered confidence in the income and stock and debt indicators, defendant gave less weight to them than to cost. Mr. Arrowsmith, defendant's appraiser in this case, testified that an investor would consider the historical cost depreciated of the plant in view of the fact that this provides a measure for what would be allowed to earn in historical cost rate jurisdiction. He also testified that cost was a good indicator of value for plaintiff because it had a very high percentage of very recent dollars invested in plant. Later, though, he testified that cost was not a good indicator of value here because cost may approach value quite closely and that is at the time of original acquisition of the property but the farther away we get from that the less certain it is as an indicator of value, particularly historical cost. Similar contradictory testimony of defendant's witnesses exists in the record with regard to whether the stock and debt approach should be utilized. At one point Mr. Arrowsmith testified in favor of using that approach and then qualified the statement to make sure it would not apply to defendant's new appraisal: I believe this indicator bears some consideration in that it reflects a measure of the stock and bond investor's estimate of the company's value. However, I believe it is far less reliable than either the cost or income indicators. I would like to state at this moment, Your Honor, that this statement was made based in description of the actual appraisal and the description does not apply to my current appraisal but was made in the actual appraisal for the 1975 assessment. Not my current appraisal. The efficacy of an argument, however, does not diminish because one no longer wishes to use it. The statements of defendant's witnesses in support of using the cost and stock and debt indicators of value were strong and we find no effective explanation to discredit that approach. Actually, it was plaintiff who offered the most criticism of the cost and stock and debt approaches through the testimony of its witnesses early in the trial. For example, Dr. Ring testified that he would give no weight to the stock and debt and suggested income be weighted at 60 percent and cost at 40 percent. He also stated, though, that he had no quarrel with a ten percent weight for stock and debt. The tax court determined that all three indicators of value should be used in this appraisal and used a weighting of 60 percent for the income method, 30 percent for the cost method, and 10 percent for the stock and debt method. The court's computations are not included in its opinion but were part of its Findings of Fact, Conclusions of Law and Decree. Our summarization of the tax court's computations follows: For January 1, 1975: Income $ 670,457,220 x 60% = $ 402,274,332 (The court used the company's actual income for 1975 of $88,031,033 and divided it by a capitalization rate of 13.13%) Cost $1,373,975,452 x 30% = $ 412,192,636 Stock and Debt $1,134,707,212 x 10% = $ 113,470,721 _____________ $ 927,937,689 Oregon Allocation Factor [4] .3369 _____________ $ 312,622,207 Add Leased Property 162,400 Deduct Motor Vehicles and Locally Assessed Plant Held for Future Use ($ 4,310,880) _____________ $ 308,473,727 For January 1, 1976: Income $ 835,512,750 x 60% = $ 501,307,650 (Actual income for 1976 of $102,684,517 divided by capitalization rate of 12.29%) Cost $1,591,678,027 x 30% = $ 477,503,408 Stock and Debt $1,319,775,994 x 10% = $ 131,977,599 ______________ $1,110,788,657 Oregon Allocation Factor .3047 ______________ $ 338,457,304 Add Leased Property 162,400 Deduct Motor Vehicles and Locally Assessed Plant Held for Future Use ($ 3,687,568) ______________ $ 334,932,136 Plaintiff asserts that this court should give substantial weight to the tax court's findings and conclusions. However, as we have expressed in Medical Building Land Co. v. Dept. of Rev., 283 Or. 69, 74 n. 3, 582 P.2d 416 (1978) and Bend Millwork v. Dept. of Rev., 285 Or. 577, 603, 592 P.2d 986 (1979), only in certain circumstances do we grant such deference. Our review is de novo, as provided by ORS 19.125(3), and we have accordingly studied the transcript and exhibits to come to our own conclusions. We find that the limitations of the three approaches pointed out by the parties should go to determining the weight to be given the individual approaches rather than to completely eliminating two of the approaches from consideration. Defendant's shift in appraisal methodology to the income indicator of value alone was accomplished without sufficient explanation why the cost and stock and debt indicators should be ignored. Not only is there data available for all three approaches, but they also serve as a check and balance upon one another. The weightings of 60 percent to income, 30 percent to cost and 10 percent to stock and debt will be used here. The remainder of the issues about which the parties disagree concern the income indicator of value. This capitalized income approach to value was described by Mr. Goodman to be the process of obtaining the present value of the future income to be derived from a property. Involved in the procedure is a determination of the appropriate income to be capitalized and of the appropriate rate of capitalization to be applied to the income. For clarity and ease of comparison with the tax court opinion, we will use the number and subject headings used by the tax court, such as heading # 1 above, Valuation Technique, though in somewhat of a different order. First, heading # 10, Income to be Capitalized, is addressed to set out the time period represented by such income and to give somewhat of an overview of what such income is to represent. Then the method of determining or projecting the income to be capitalized is addressed under heading # 4, Performance Ratio Used to Project Income. Separate elements of income, including heading # 5, Construction Work in Progress, heading # 7, Rate Increases, and heading # 9, Defendant's Treatment of Deferred Taxes are discussed next. Related to heading # 9 is heading # 3, Depreciation  Flow-Through Accounting, which concerns defendant's treatment of deferred taxes and investment tax credits. Then factors related to capitalization, including heading # 2, Annuity Method of Capitalization  Treatment of Depreciation and heading # 11, Rate of Capitalization are the final subjects to be addressed. [5] Before addressing these issues we believe it is helpful to briefly set out the parties' income approaches. Plaintiff sought a projection of income for the assessment year and asserted the best means of obtaining that value is the least squares method. Dr. Ring defined the least squares method as a statistical method by which a line is drawn from which the actual highs and lows [of past income] are equally given effect so that the line matches the performance and normalizes the highs and lows of a corporation. Actually, plaintiff apparently used this method more as a check on the company's actual income figure of $88,031,033 for January 1, 1975, and estimated income figure of $100,000,000 for January 1, 1976, figures which plaintiff used in its computations. Defendant utilized a performance ratio in determining the income value, dividing plaintiff's adjusted net utility operating income by its average earning plant. The ratio was then applied to plaintiff's total year end plant to achieve a value to be capitalized. In developing its performance ratio defendant took as the numerator plaintiff's adjusted operating income for 1974, which was determined by taking plaintiff's 1974 reported operating income of _______________________________________ $74,246,000, deducting investment tax credits of _____________ $ 2,349,000, adding a provision for deferred income taxes of ____________________________________________ $ 2,625,700, and removing the partial year effect of a rate increase granted in 1974 of ___________________ $ 4,865,000, and adding the annual provision for depreciation in 1974 of ____________________________________ $27,329,600, giving an adjusted operating income of ________ $96,987,300. For the denominator defendant took the cost of average earning plant, including all plant in service, property held for future use, acquisition adjustment and materials and supplies which defendant computed to be _____________________ $1,004,869,000. The resulting ratio was determined to be _____ 9.65%. Defendant then took the total year end plant, the cost of the plant including construction work in progress (CWIP) at assessment date, at cost of ________________ $1,367,302,600, and multiplied it by _________________________ 9.65%, resulting in a probable future operating income (PFOI) value of ____________________ $ 131,944,700. To the PFOI defendant then added the annual effect of 1974 rate increases of ___________ $ 17,000,000, and 1975 rate increase of ____________________ $ 8,580,000, giving a total income to be capitalized for January 1, 1975 of _________________________ $ 157,529,700.