Appeal by Mebane Home Telephone Company under G.S. 7A-30(3) from the decision of the Court of Appeals, reported in
Sharp, Chief Justice.*fn1 Justice Britt and Brock did not participate in the consideration or decision of this case.
I. Determination of "Fair Value"
In the hearing which gave rise to this appeal, the Utilities Commission found that the reasonable original cost, depreciated, of Mebane Home Telephone's property in North Carolina was $3,946,594 and that the depreciated replacement cost was $4,244,361. Having made these preliminary findings, the Commission concluded that the "fair value" of Mebane's property should be derived by giving a 1/10 weighting to depreciated replacement cost and a 9/10 weighting to original cost. To the figure obtained from this weighting ($3,976,371) it added an allowance for working capital of $73,355 and investment in Rural Telephone Bank Class B stock of $118,500 to reach a "reasonable fair value" of $4,168,226. The weighting process used by the Commission resulted in a "fair value increment" of $29,777. The Commission also found that Mebane Home Telephone's capital structure consists of 81.86% long-term debt (largely in the form of low-interest loans from the REA), 10.28% common equity, and 7.86% cost-free capital.
In its second assignment of error, which we elect to consider first, Mebane contends that the Commission improperly based its weighting of original cost and replacement cost on the Company's ratio of debt to equity and that this resulted in Mebane's estimates of replacement cost being given only "minimal consideration."
Under the statutory scheme in effect at the time Mebane filed its application, its rates were set in accordance with the formula of "a fair return on fair value," a test first set down by the U.S. Supreme Court as a constitutional requirement in Smyth v. Ames, 169 U.S. 466, 42 L. Ed. 819, 18 S. Ct. 418 (1898). In Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 88 L. Ed. 333, 64 S. Ct. 281 (1944), the Supreme Court decided that this test was no longer required by the due process clause. Notwithstanding, at the time Mebane filed its application for a rate increase, it was still followed in this State as a matter of
statutory law.*fn2 At that time, the statute which controls this case, G.S. 62-133, read in pertinent part as follows:
§ 62-133. How rates fixed. -- (a) In fixing the rates for any public utility subject to the provisions of this Chapter, other than motor carriers and certain water and sewer utilities, the Commission shall fix such rates as shall be fair both to the public utility and to the consumer.
(b) In fixing such rates, the Commission shall:
(1) Ascertain the fair value of the public utility's property used and useful in providing the service rendered to the public within this State, considering the reasonable original cost of the property less that portion of the cost which has been consumed by previous use recovered by depreciation expense, the replacement cost of the property, and any other factors relevant to the present fair value of the property. Replacement cost may be determined by trending such reasonable depreciated cost to current cost levels, or by any other reasonable method.
(2) Estimate such public utility's revenue under the present and proposed rates.
(3) Ascertain such public utility's reasonable operating expenses, including actual investment currently consumed through reasonable actual depreciation.
(4) Fix such rate of return on the fair value of the property as will enable the public utility by sound management to produce a fair profit for its stockholders, considering changing economic conditions and other factors, as they then exist, to maintain
its facilities and services in accordance with the reasonable requirements of its customers in the territory covered by its franchise, and to compete in the market for capital funds on terms which are reasonable and which are fair to its customers and to its existing investors.
This statute directs the Utilities Commission to "consider" both original cost and replacement cost in ascertaining fair value. However, neither of these is the measure of "fair value." They are merely evidence of that figure to be considered by the Commission in the exercise of its independent expert judgment. Utilities Commission v. Power Co., 285 N.C. 398, 412, 206 S.E.2d 283, 294 (1974); Utilities Commission v. Telephone Co., 281 N.C. 318, 339, 189 S.E.2d 705, 719 (1972).
It is the clear intent of former G.S. 62-133(b)(1) that the Commission use its own expert judgment as to the credibility of the evidence in the record and the weight to be given to it in "considering" the indicators of fair value which are themselves supported by competent and substantal evidence. Utilities Commission v. Power Co., 285 N.C. 377, 389-90, 206 S.E.2d 269, 278 (1974); Utilities Commission v. Telephone Co., 281 N.C. 318, 358, 189 S.E.2d 705, 730 (1972). While the Commission may not brush aside the of the prescribed indicators by giving it "minimal consideration,"*fn3 this Court will not disturb an order of the Commission merely because we would have given a different weight to each of the indicators of fair value. Utilities Commission v. Telephone Co., 281 N.C. 318, 339, 189 S.E.2d 705, 719 (1972). It is the prerogative of the Commission to determine the credibility of the evidence, even when the evidence is uncontradicted by another witness. Utilities Commission v. Power Co., 285 N.C. 377, 390, 206 S.E.2d 269, 278 (1974).
Our review of the record in the instant case reveals ample support for a substantial discounting of replacement cost as an indicator of fair value. Among the factors the Commission considered in judging the credibility of Mebane's estimate of replacement cost and then weighing that figure to arrive at "fair value" were (1) the failure of the Company's expert witness to take obsolescence
into account in calculating replacement cost, (2) the lack of reliable data upon which to base a proper study of that figure, and (3) the fact that Mebane had recently made a major replacement to plant in the form of a new million dollar central switching office.
The Chief of the Operations Analysis Section for the Utilities Commission, Allen L. Clapp, testified that the Company's expert witness had overstated replacement costs by calculating a trended reproduction cost for Mebane's plant in service and then using that figure as an approximation of replacement cost, with no deduction for obsolescence. The Commission indicated in the discussion of its findings and conclusions that it had considered this oversight in weighing replacement cost to arrive at "fair value":
Although the term "replacement cost" envisions replacing the utility plant in accordance with modern design techniques and with the most up-to-date changes in the art of telephony, trended original cost as presented by the Company is founded upon the premise of duplication of much of the plant as is, with certain inefficiencies and outmoded designs included. While obsolescence can, to an extent, be accounted for in proper depreciation treatment, the economies of scale inherent in the telecommunications industry (e.g., employing one 600-pair cable down a road instead of six 100-pair cables installed over a number of years) are not fully recognized in the trending process.
Obviously, the "fair value" of a utility system cannot exceed the present cost of constructing a substitute system of modern design. Utilities Commission v. Power Co., 285 N.C. 377, 392, 206 S.E.2d 269, 279 (1974). When a utility's expert witness fails to take obsolescence into account in calculating replacement cost, this is a fact which the Commission may properly consider in weighing replacement cost to arrive at fair value. Utilities Commission v. Power Co., 285 N.C. 398, ...