
10 F.2d 519 (1926)
MIDDLESEX WATER CO.
v.
BOARD OF PUBLIC UTILITY COMMISSIONERS OF NEW JERSEY.
District Court, D. New Jersey.
January 7, 1926.
*520 *521 *522 *523 *524 *525 *526 *527 *528 *529 *530 Frank Bergen, of Newark, N. J., for complainant.
Thomas Brown, of Perth Amboy, N. J. (Frank H. Sommer, of Newark, N. J., of counsel), for defendant.
Before DAVIS, Circuit Judge, and RELLSTAB and CLARK, District Judges.
RELLSTAB, District Judge.
This suit seeks to enjoin as invalid the defendant's rate order of July 24, 1924, made effective as of April 1st of that year. The case is before us (sitting under section 266 of the Judicial Code, as amended by Act Feb. 13, 1925 [1925 Supp. U. S. Compact Ed. pp. 69, 70]) on final hearing on exceptions to the master's report, filed by both parties. Those of the plaintiff are said to be but precautionary, and were not pressed at the hearing.
The plaintiff is a New Jersey corporation, and under state legislative authority owns and operates a waterworks and distributing system, supplying water for public and private use. The defendant is a commission of that state, possessing regulatory powers over the services rendered and rates charged *531 by the public utilities of the state. The sole question before us is whether the rates prescribed by the defendant are confiscatory. The master, in a very helpful discussion of the issues, reached the conclusion that they are and should be annulled. The crucial questions relate to valuation.
The defendant found that the plaintiff's service was not up to the required standard, and that the value of its property for rate-making purposes, as of December 31, 1923, including cost of a proposed 24-inch transmission main "needed to adequately supply the needs of the consumers," which it estimated would cost $454,020, was $2,190,200, and that a fair return to the company on such valuation, "subject to the provision that the service rendered by it shall be safe, adequate, and proper, is $160,000." The defendant's summary of the elements of the gross revenue required is as follows:


  Return upon investment (with safe,
   adequate, and proper service) ..... $160,000
  Operating expenses .................  122,386
  Annual depreciation ................   22,500
  Taxes ..............................   58,240
                                       ________
  Gross revenue required ............. $363,126
  Revenue collected in 1923 ..........  280,680
                                       ________
  Indicated increase (29.3 per cent.)  $ 82,446

To realize the required revenue, it increased the rates, but provided that a deduction of 10 per cent. be made on "all bills to be rendered, except to associated companies and for miscellaneous water service, * * * until such time as the company shall have given satisfactory evidence that it is rendering safe, adequate, and proper service to both public and private consumers."
There is substantial agreement between the parties as to the kind and quantity of the plaintiff's properties used and useful in carrying on its business. Indeed, the experts of the defendant accepted as accurate the inventory furnished by the plaintiff, and made it the basis of their testimony. As stated by the defendant in its rate decision, made a part of the answer herein, "both appraisers (Nicholas J. Hill, Jr., plaintiff's main expert on valuation, and Water A. Shaw, principally relied upon by defendant) used the same inventory of the physical property, and as far as pricing this inventory is concerned and before adding overheads the two appraisers are in close agreement."
The defendant, in dealing with the value of plaintiff's property, said:
"The basic test of the reasonableness of rates is the fair value of the property used and useful in the service of the public. The determination of that value is a matter of reasonable judgment, based on all relevant facts. It is not controlled by artificial rules or formulas. In this determination the original cost of the property, the expenditures for permanent additions and improvements made since the original construction, the present and probable future cost as compared with the original cost to reproduce the property, accrued depreciation, including deferred maintenance of the property and proper allowance for overheads, working capital, and intangibles are all elements to be considered. Neither the present nor the original cost to reproduce the property, nor the amount of securities outstanding against it, can be considered as the controlling element in determining its fair present value for establishing rates."
What consideration was given to these several elements, and how and to what extent each was applied in determining the value of the plaintiff's property, does not appear in the defendant's report. It contrasted the different views and estimates of the experts, particularly those of Hill and Shaw, but gave little indication of the reasons controlling its decision. Shaw gave no opinion as to the value of the plaintiff's property. Hill valued it at $2,500,000. This was the valuation found by the master. Hill and Shaw disagreed as to the weight to be given certain of the elements concededly to be considered in ascertaining values, and radically differed in the method of ascertaining accrued depreciation.
In the proceedings before the defendant, the valuations were made as of December 31, 1923, while those in the present proceedings were brought down to September 30, 1924. The items of properties inventoried as of the earlier date are the same in both proceedings. The inventory in the present proceedings includes additions made since December 31, 1923, and embraces the changes in prices since that date. Hill fixed the amount of the additions at $60,619, and Shaw acceded thereto.
Hill had an inventory of the properties in place made. He ascertained the quantities thereof by field inspection and measurements, and by using the plaintiff's records relating to the construction of its plant. He then personally inspected the properties. Before the defendant he appraised them as of December 31, 1923, and in the proceedings before us he used the prices current at about September 30, 1924. He divided the properties *532 into tangibles and intangibles, and appraised them undepreciated and depreciated.
As to the properties undepreciated:


  The tangibles in place on December
   31, 1923 he appraised at ........  $2,433,294
  And the additions from that date
   to September 30, 1924, at .......      60,619
                                      __________
  Total at latter date .............  $2,493,913
  To this he added for overheads,
   17½ per cent. ...................     436,435
                                      __________
  Total gross cost of physical
   property at latter date .........  $2,930,348
  He then added for working capital       70,000
                                      __________
  Total of tangible property as of
   September 30, 1924 ..............  $3,000,348

Under the head of intangibles he added:


  For organization cost .... $ 37,500
  For going value, 10 per
   cent. of the total gross
   cost of the physical
   properties ..............  293,000
                             ________
  Total of intangibles ..............    330,500
                                      __________
  Making the grand total of all
   properties undepreciated ......... $3,330,848

Shaw's inspection of the properties was very limited, extending not over two days. He adopted the inventory made by Hill as to quantities, after spot-checking and satisfying himself that it was accurate. He also appraised the properties undepreciated and then as depreciated.
As to undepreciated: He made two appraisals, embodying two different classes of prices. In the one he applied "unit prices representing the cost of labor and material during the year 1914 and 1915" as to the properties in place December 31, 1915, and as to that subsequently acquired he took the cost to the company. In the other appraisement he applied "trend prices" as of September 30, 1924, and then added property acquired thereafter at the original cost.


  In his first, he appraised the
   properties in place, December
   31, 1915, at ................ $  825,632
  And the property acquired
   thereafter to September 30,
   1924, at ....................    535,532
  To this he added working
   capital .....................     55,000
                                 __________
     Total ..................... $1,416,164
  In his second, he appraised
   the property in place
   December 31, 1915 at ........ $1,839,573
  And that acquired between that
   date and September 30, 1924,
   at ..........................    626,898
  He then added for working
   capital .....................     55,000
                                 __________
     Total ..................... $2,521,471

None of these appraisals included anything for the company's source of water supply. Hill's appraisal, both before the defendant and in this suit, included the value of the land exclusive of the water supply. Shaw did not include land values in his appraisals in these proceedings or in those before the defendant. Adding to Shaw's appraisal, based on "trend prices," the value of the lands as appraised by others, and which the defendant accepted, viz. $133,854, the total value of the properties as of September 30, 1924, undepreciated, on the basis of this appraisal of Shaw, would be $2,655,325. Hill added 17½ per cent. for overheads as a separate item. Shaw made no separate item for overheads, but said that he included them in his appraisal of the properties in place, by adding 13 per cent. to the unit cost referred to. Nor did he add cost of organization as a separate item, for which Hill added $37,500.
An examination of Shaw's detailed "overhead table" does not disclose organization cost as an item, and a comparison of Hill's and Shaw's "overhead tables" shows that they embrace the same character of items. Shaw made no specific allowance for going value, explaining that, in making his appraisal, he treated the plaintiff's property as a going concern with a connected business, and that if it had been otherwise the properties would have had only junk value. Hill made a separate allowance of $293,000 for going value, being 10 per cent. of the appraised value of the tangible property as of September 30, 1924, including the overheads. He distinguished going value from development cost, saying that the former represented the cost of attaching the business to the properties after the physical structures were completed, and "that in every utility, after the physical structure is completed, there ensues a period during which it is necessary to develop the business and income of the property, or to attach the business to the property; * * * that a property with an established business and income is worth more than the bare bones of the plant."
It will be noted that, in both of Shaw's appraisals, he took December 31, 1915, as the date for his first appraisement. This was the method employed by him in testifying before the defendant, at which time he appraised the property in place on that date at $824,632, using the pre-war prices for that purpose. This amount is but $100 less than he testified to in the present proceedings, and may be a typographical error.
The defendant's valuation of structures as of the same date was $1,070,762, an increase *533 of $246,130 over Shaw's. No explanation is given as to how the defendant arrived at this figure, but when it is compared with the appraisal that Shaw made before it on the basis of "reproduction new  1923 prices," viz. $1,852,850, it is apparent that the defendant gave little weight to the cost of reproduction new test in ascertaining values.
The defendant in its decision gave separate values for land and rights of way, overheads, cost of organization, and going value, following Hill's rather than Shaw's methods in those particulars. As to lands, etc., the defendant accepted Hill's valuation of $133,854, but allowed only $125,154 thereof, on the ground that certain lands and equipment included in the Hill appraisal were not "devoted to the service of the customers and municipalities served directly by the Middlesex Water Company."
As to overheads, the defendant allowed 15 per cent. on structures existing December 31, 1915, which amounted to $160,614. As to the cost of organization and going concern value, the defendant adopted Hill's percentages; but, as it applied them only to the structural cost, the amount allowed by it was about $12,000 less for organization cost and about $23,000 less for going value than allowed by Hill. The defendant's allowance for working capital was $62,500, which is $7,500 less than Hill's.
There is nothing in the defendant's report that indicates how these particular amounts were reached, but it is noted that, as to overheads and working capital, the only two of those items for which a comparison is available, the amounts allowed by the defendant are about midway between those allowed by Hill and Shaw. This may be only a coincidence, but it suggests "splitting the difference."
The defendant's valuation of the plaintiff's property as of December 31, 1923, undepreciated, was $2,113,909; that of Hill before the defendant, at current prices of about the same date, $3,215,065; that of Shaw before the defendant, at 1923 prices, by adding thereto land values, $2,611,817. This comparison also shows that the defendant gave little heed to the reproduction cost new method in ascertaining values. If to Shaw's appraisal is added the defendant's allowance of cost of organization, $25,492, and going concern value, $169,951, making a total appraisal value of $2,807,260, the failure of the defendant to follow the reproduction cost new test is emphasized.
The World War conditions radically increased the cost of labor and commodities of all sorts. Previous thereto the level of prices was practically stable. While the peak in high prices has passed, and there is reason to believe that it will not permanently return, yet the prevailing prices continue to be considerably higher than they were in 1915. Fluctuations there are, but the general level in prices persists in continuing much higher than they were prior to the war, and clearly negative that they are but fleeting, or due to temporary conditions. While these higher levels continue, they must be given effect in fixing the rate base, as it is not the past (historical), or the future (speculative), but the present, fair value that must be ascertained.
The defendant, in our judgment, leaned too heavily toward the pre-war prices in its fixing of the rate base, and in so doing it erred. The master was much impressed by Hill's valuations and his methods in arriving at them. In the main, we likewise are so impressed. His fixing the value of the plaintiff's property in question, undepreciated, at $3,330,848, is well supported by the testimony, and we find it as one of the facts in the case.
As to the properties depreciated: In the present proceedings, as well as those before the defendant, Hill ascertained depreciation by adopting the sinking fund method, using an interest rate of 3 per cent., while Shaw used the straight-line theory, which excludes the effect of interest accumulated on the periodic contribution to the depreciation fund. Before the defendant, Hill fixed the depreciation on values, based on prices current December 31, 1923, at $336,660, giving the properties a depreciated value of $2,878,405. Shaw's estimate of depreciation before the defendant, as of the same date, as applied to his appraisal at 1923 prices, was $677,517, and he figured the property thus appraised, depreciated, at $1,800,446.
The defendant approved Shaw's method in determining depreciation, which, as it stated in its report, "results in approximately twice the amount of accrued depreciation obtained by Mr. Hill," and ordered "that 25 per cent. should be deducted from the value new of structures and equipment for accrued depreciation." The depreciation thus figured amounted to $424,878. As fixed by the defendant, the value of the property so depreciated was $1,689,031. This the defendant did, notwithstanding that it found that the plaintiff's mains constituted about *534 one-half of the value of its tangible property, and that sections of the mains submitted to it "showed that after years of use the mains from which they were cut showed little or no deterioration whatever."
In the present proceedings, Hill estimated the depreciation as of September 30, 1924, at $357,756, and appraised the property depreciated at $2,973,092; Shaw estimated the depreciation as of the same date (as applied to his appraisal, wherein he took the "trend prices" of that time) at $709,696, and appraised the property depreciated at $1,811,765. It will be noted that Hill's and the defendant's charges for depreciation are not far apart.
The plaintiff attacks as arbitrary both the straight-line and sinking-fund methods in ascertaining depreciation, and contends that the actual observed depreciation test is the only just method of determining depreciation of properties situated and used as are those of the plaintiff. We do not deem it necessary to determine this phase of the controversy, for, if we ignore Hill's method of ascertaining depreciation and accept that of Shaw, which results in the largest amount of depreciation, the net value of the plaintiff's properties depreciated still exceeds $2,500,000, the value stated by the plaintiff in its schedule of increased rates filed with the defendant, and found by both Hill and the master.
After giving full consideration to all the testimony bearing on valuations, we have reached the conviction that the fair value of the plaintiff's properties, useful and used in its business in securing and supplying water on December 31, 1923, and September 30, 1924, the respective dates to which the testimony of value related, is not less than the sum of $2,500,000, and we determine the value of such property for the said purpose at that amount. We reach this result without making any allowance for the sources from which the plaintiff obtains its waters.
The rates fixed by the defendant, even if permitted to be collected in full, were estimated by it as a fair return on a valuation considerably less than $2,500,000. With the 10 per cent. deducted from the rates, as ordered by the defendant, the return on the valuation of $2,500,000 would be less than 6 per cent., which, in these days of inflated prices, or, in other words, diminished purchasing power of the dollar, in our judgment, makes the rates permitted to be collected confiscatory.
In thus considering the 10 per cent. deduction ordered by the defendant, we are not unmindful that proper and adequate service requires the laying of a larger transmission main, and that in some circumstances the withholding of a portion of an authorized rate might be amply justified. However, on the record before us, there is nothing to justify the conclusion that the plaintiff is culpable for not having laid such a main. Before it can be so held, it must be afforded an opportunity through reasonable rates to earn, not only enough to produce a fair return on the value of its property, useful and used in the public service, but enough more to enable it to secure the capital necessary to install the required main and other facilities adequately to care for the increasing demands of a constantly growing population. This the rates allowed, even though not subject to the discount referred to, would not do; a fortiori, it could not be accomplished by still further reducing the returns, through subjecting the rates to the 10 per cent. deduction ordered.
For these reasons, we are of the opinion that the rates under consideration are confiscatory and invalid, and should be enjoined. The exceptions to the master's report are overruled, and his report is confirmed. Let a decree be prepared in accordance herewith.
