This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
The preliminary analysis and review of the underlying conditions has been best standardized, perhaps, in public utility fields. A great number of projects of this nature have been presented during the last two decades, and bankers have worked out and come to accept certain well-defined standards. They know, for instance, the approximate amount of gross earnings which can be expected from a given population. Their preliminary estimates of earnings are based upon approximately the following probable yearly receipts, from each person in the territory covered by the public utility: †
Electric light and power companies,..........
Electric street railways in small cities,..................
Electric street railways in large cities,................
The New York Annalist describes the preliminary survey of electrical railway projects as follows:
* Dewing's "Corporate Promotions and Reorganizations," pp. 251, 272, 484. † From "Promotion and Organization of Public Service Corporations," by L. R. Nash, of the Stone and Webster Engineering Corporation.
There are 25 or 30 banking houses in New York City that specialize in financing electrical railways. Each of them is supposed to receive 500 to 1,000 proposals for building new lines or purchasing and rehabilitating old lines each year.
In judging these new projects, the bankers take into consideration, first of all, the political attitude of the state or city in regard to public utilities. They have on file tabulated data with regard to the political record and activities of each state. They consider, next, the United States census figures of population and statistics, which indicate the rate of growth of population.
Next, the promoter is asked to pay the expenses and fees of an expert engineer designated by the banking house, who makes a preliminary survey of the proposed line. He tabulates the number of cuts and fills and arrives at an approximate estimate of the cost of construction. He also inquires closely into the cost of rights of way and of terminals. His advance estimates of cost of construction and operation are generally expected to come within 5% of the actual figures.
This preliminary report is then checked against the previous experience of the house. They add to the cost of construction the carrying charges on the investment before it begins to make any return. They may get bids on the construction of power plants. This office analysis and checking is expected to result in very accurate estimates of gross earnings and of outgo.
Some bankers decline to take up any such propositions unless advance estimates show net interest earnings equal to two and one-half times the interest charges on the bonds that will be necessary. Each mile of track should earn a minimum of $5,000, which is a generally accepted figure for interurban roads.
If the operating cost is 60%, this leaves net earnings of $2,000. If the construction cost is $25,000, all provided by bonds at 5%, the interest charges per mile are $1,250, leaving $750 per mile to provide for depreciation, unexpected losses, and accidents.
A population per mile in a strip two miles wide on each side of the road of one thousand is considered a safe minimum. The interurban railroad which exists mostly on paper is not in large favor, as it is believed that most of the choice locations have been occupied.*