Financing New Developments RICHARD G. WOODBRIDGE, IU NEW YORL LIFE NSUIUNCE CO. 51 WADISON AVL, NXW YORL 10, N. 1.
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development. to a busin- man. in just MOW busin- d d o p n w n t and ita financing is a budIW operation. Following thr introduction of some basic U n o l a g y . wasa (u. presented in which vutous (diEerantiatd by &e, newnu, etc.) chemical mnterphw hsn bm and bdng f i n ~ d .Th. finanoin(l history of tlu D o l Clumiul Co. L uned M an example.
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U8INEBS and commerce have msny facete. 8aientlsta and engineem are concerned primsrily with pbysical sspectrr-with technology. There sre other operations auch as enlea, purchasing, acoounting, peraolunel, and finance, all of which must interlock and mwh together much as the functions of a
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it seems appropriate to say a few words about thase aspeota of money and hance which are wrbhent. ckmenrlly there are two kinds of money-commonlg referred to M debt and equity. Debt money is money which has been borrowed. It has to be paid back, invarisbb within a definite period of tlma An long M the borrower haa the money he generally is obliged to pay the lender interest. To protect the lender, the b o r n may sleo be required to pledge some item or items of value which will become the pmssession of the lender in the event the borrower is unable to repay the loan. The thing or thhga of value pled& on a loan are referred to as collateral. They are part of ths seourity behind the loan. When a loan iS dby d p r o p erty (land or buildings) it is a mortgage; when the Secuity is property other than d &ate it in a chattel mortgage. Some times loans are s m r e d by the pledge of atocka and bonds or n e w tiable paper, such as warehouse receipts which can be freely bought and sold, or by personal effects. The actual agreement between the borrower and lender-i.e., the evidence for the debGmay be in the form of a note(s) or bonds. Both are evidence of indebtednees. The compledty of the agreement is usually a reflectionof the complexity of the situation. A simple note may be only a printed form with blankn where the appropriate names, dates, and places may be Ned in; on the other hand, an indenture for a loan to a complex corpor& tion may be an imposing printed to-the product of aaveral lawyers, covering many covenante (sgreementa) between the borrower and lender($ pertinent to the loan. Notes am uaed when there are a limited number of lenders; bonds are used w h a plurality of lenders is involved (such M the public), in which case a trustee usually entam the picture. The trustee,in a sense, representa the lenders as a body. It would be quite impracticable for a borrower to negotiate individually with thousands of bondholders should, for example, a modi6cation of the indenture prcvisions be found desirable. A debenture bond is a bond which is unaecured. An income bond is a bond the intereat on which is contingent upon earninge. It is i m p r t m t to d i s e that debt money must be repaid and that interest payments must be met. Because of thene l e d obligations, notes and bonds of business enterprises have classically been considered to be “eafer” investments than their stocks. Equity money is ownership money. It is the money which, m a sense, is possessed by an individual or enterprise. An far ea an enterph is concern& equity money may represent the money which the owners ofthe enterprias originally put into the businen plus money which the enterprise has earned and retained to iteelf. For various reasons, accountants segregate the amount of money “contributed” by the ownem from the amount of money earned and saved by an enterprise, the latter being held in an account entitied “earned surplus.” while changw in earned surplus may reflect u e v d things (such as setting up resemes), an anal+ of this account will usually Indicate how a company is using the money it earns and s a w . Ownership in a corporstion is repreeented by dooumentary evidence, generally in the form of stock certificates. A stock d c a t e not only is evidence of ownemhip but also is evidence of the partioular owner‘s share h the totd ownership of an enter-
living organiammust openate-harmomoniously. Although this is often &e to be an age of specialisation, it ia the well rounded, knowledgeable men who usually are aaIect.4 to 6l1 rwpamible positiow-men who have an appreciation and w o r b g knowledge of the manifold operations of an enterprim, whether it be a university laboratory or a businwa entsrprise operated for profit. Thta paper describes one of tbe linancial aspects of enterprisps. I t outlines the methods by which businem enterprba obtain money. In a general manner the kmds of businen enterprises that mquire money are clas%ifiedas (1) new entsrp-pmticuIsr attention is given to the new, small company; (2) establiehed, d l ~ncernf.-“small concern” is used to describe companies w h w management decisions are made by one or two men (7); and (8) large, established companies. It is the author‘s hope that technical readers will gain from this diseuasion a greater appreciation and understanding of the problems faced by Wase reapansible for Soancing our businen and commerce. When Bcientista and engineers hear the word developmeut, they usually think of a technical development. The other members of an enterprise may have a somewhat different concept of thin term. One of the functions of the so-called development department of one of our large chemical companies is the analysis and evaluation of activities into which that company might expand. It is concerned with busin- developments. From the buainesmm’s p i n t of view, a technical development is just one of many busin- developments and is evaluated on a businem basis. A technical development is not financed sny d i a s r e n t l y h any other buainem development raquiringmoney. However, it is imprtant to realize that the glamorisation and promotion a t present passible with new technical developments @assible primarily because the investing public is interested though ignorant of technology) d t a in teclmid developments being M a s a peg on which to hang many financial promotions. For example, one company needed a substantial sum of money to replaoe ita old equipment and bring ita weta in line with ita competitors. The company also wanted to build a small new plant to make a new product, but had only enough funds of its own to do one of them. It used its own funds to catch up with its competitara, and made the new plant and product the central theme of the promotion behind a new stock h e . Any apeoisC financiosmust be viewed in tmmn of a multiplicity of faotma. Inaroauch as thia report is concerned with money and h c e
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prise. When a corporation is organized, the organizers decide how many shares will comprise the total ownership. An owneri.e., a shareholder or stockholder-may own any number of shares from one to the total number issued. There are degrees of ownership, based on such things as which owners are to be paid first and how much and, in times of trouble, which owners get first claim on the assets that remain after satisfaction of creditors or debt holders. There are two well recognized degrees of ownership-preferred and common. Preferred means that the owners of that class of stock have a preferred position over the other stockholders. They have first claim on profits, and in times of trouble have first claim on whatever is saved from the holocaust. For this preferred position, however, their share in profits is generally a fixed number of dollars, no matter how much the enterprise earns; usually preferred shareholders do not have a vote on matters of company policy. Generally common stock holders share equally in all profits left after paying the preferred dividends. Obviously, if a business prospers greatly the common stockholders are in a position to reap most benefit from successful operation. Common share holders usually have a vote on matters of company policy. There are various classes of preferred stock: Cumulative preferred is stock on which yearly dividends, if not paid, accumulate, and, theoretically, must eventually be paid. Convertible preferred may be changed into common at the option of the owner. (There are also bonds which may be converted into stock.) Callable preferred is stock that may be called in by the company which issues it, usually at some predetermined price, and participating preferred, in addition t o its b e d dividend, shares with the common, on some predetermined basis, in further dividend disbursements. Some preferreds have sinking fund provisions under which a specified amount is retired each year. That there are gradations of “securities” from pure ownership to pure debt should be obvious and also that there are many ways of financing. An extremely important factor, which is too little considered except by the more theoretical economists, is called “profits” (6). Usually the actions of an enterprise maximize the profits of the person or group in control of the enterprise’s affairs. This does not mean that those in control wish to mulct other interests because to do so would not necessarily work to the long-range advantage of the group in control. It is often “Who will profit and when?” that influences many business decisions, and this question is of paramount importance in setting up financial operations. Although such situations are most obvious in terms of equity money, they are also present in debt money situations. There are numerous examples of financial actions that have resulted in benefits to one or another class of bondholders. In a crude sense, it is the old conflict between “thine and mine.” Business ownership is a common dream among engineers and scientists. Therefore, let us consider how the new enterprise that wants a relatively small amount of money may be financed. There is a small company in Pennsylvania which started 6 years ago to make fine chemicals. The company was started on $8000. After a year and a half, more money was needed to buy additional equipment. The owner borrowed $5000 from the local bank secured by a mortgage on his home, and was able to borrow a large drum dryer from a customer. More recently a contract for chemicals was negotiated with one of the large chemical companies; now, another $25,000 is needed for equipment, and other forms of financing will be necessary. Another small company got started this way: A young instructor of engineering in one of our major universities, after considera ble investigation on his part, became convinced that there were unexploited opportunities in the field of the application of electronic-mechanical devices to testing and research equipment. This instructor had no funds of his own, and none of the banks he approached would lend him a cent. An official of one of the banks, however, put him in touch with three local businessmen
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who were looking for capital gain opportunities for personal f u r d s The deal which was worked out went something like this: The three businessmen made a loan to the new company. The loan was guaranteed personally by the young engineer. The loan w&* in the form of a note. At the option of the three buuinemncri the note was convertible into common stock of the compnri? (Each of the four involved would have 25% of the stock aftc: conversion.) After several years the debt was converted i n t o stock. Eventually, one of the original lenders and the man uf-ro started the company bought the stock held by the other two original investors. Subsequent expansion necessitated further ftnancing. This was arranged through a local bank which r e quired both men to endorse the note personally. As the cnmpany grew, more money was needed. Stock was sold, mostlg to farmers in the neighboring county, and a bank in a large nearby city made a mortgage loan to the company secured by fhr, physical assets of the enterprise. Do these two examples recall to mind the early financial struggles of Herbert H. Dow of the Dow Chemical Co. or of J o h Francis Queeny of Monsanto whose initial capitalization is said to have been $5000, most of it borrowed. There are several things which may be pointed out that appear to be common to these examples: (1) the very personal and locd nature of the financing; ( 2 ) the use of the entrepreneur’s own re sources and credit; (3) the continuing nature of the financing: and (4)the necessity for the technical entrepreneur to be sueoewiful in operations outside the field of his specialty. If a very new, independent company requires more financing than relatively modest amounts, generally speaking the financing is still on a very personal basis, although a wider area may have to be covered. It may take a great deal of searching to find enough willing people with enough money. Leads are usually developed by personal contact with banks, brokerage houses. investment banking houses. and individuals who make up tjie financial fraternity. For a new enterprise requiring either moderate or large SI~XUR, probably the commonest route is assistance from an already established concern or concerns. Such route may involvr actual affiliation. Also it should be kept in mind that many x young man with a bright idea has affiliated himself with an estnihlished enterprise and, within the framework of the enterprise, habuilt a business of which he is virtually boss and in which be ha.% an equity position. Another method of financing a new business using the credit of an established enterprise is via purchase contracts (firm ab to amount, price, and duration) from the established enterprise ~ i the new enterprise for the product to be made. This is a procedure sometimes sought by officers of a going concern to establish a company in which they can have an equity position with the hope of eventually reaping a capital gain. A new enterprise may trade on the credit and/or reputation of established concerns. This is exemplified in the recent financing of the Chemstrand Corp. The high reputation of the stockholders, Monsanto, and American Viscose were undoubtedly major factors in the succeMfu1 sale of over $100,000,000 in firat mortgage bonds (9). Although the direct sale of stock and bonds in new enterprim to the public is not as prevalent as i t once was, this is a route which has sometimes been followed. Its success generally depends on the receptiveness of the public and the persuasiveneb; of the promotors. Small, established enterprises requiring funds generally ORII finance minor needs. For more than minor needs, established enterprises, having real property to pledge as security and an established economic history, usually can borrow from banks for the funds required for new developments or other purposa>, Perhaps a few words are in order on the kinds of bank loan. available to small businwses (6,IO):
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1. Character loans. unseoured Ioana based on such things as the applicant’s past ahd expecttd future record of produLtion, sales,,profitsbihty, management ability, and general businem a t y d y They are generally for short te-i.e., under 1 year. erm loans (loans reoavable over a oericd of more than 1 year) from banks average aboh 5 years. 3. Lonna secured by a pledge of accounts receivable are often usedb smsllbusinesaes. 4. %ans secured by inventories. Some banks will lend money on warehouse stocks. The security in such c ~ s e ais a warehouse or field warehouse receipt. 5. Epuipment loans can sometimes be secured by liens on equipment. , 8. Loans based on chattel mortgages. 7. Mortgage Ion business property There are other sources of funds for small businesses. One which bas been noted (4) is that of factors. Factoring companies are used extensively in the textile field and are being wed to some extent by other indnstries. Factors buy the accounts receivable of their clients. For example: Company A sella goods to companies B, C, and D. The obligations of B, C, and D to pay A for the goods wnstitnte A’s accounts receivable. The date the receivables become due depends on the terms agred to by the companies involved. If A’s factor buys them receivables A can, if it is so desired, receive the money immediately from his factor. If A takes the money before the factor collects the accounts receivable, A pays the factor intexest on the amount he has taken-Le., the amount the factor had advanced to A. (The factor will pay interest to A on any money left with the factor after the accounts receivable have been collected.) Usually, receivables am sold to a factor on a “without reconrae” be&-i.e., A is not responsible if B, C, or D does not pay up. As has been intimated, the factor is responsible for the collection of the receivables. The factor receives a fee for this and other services he is in a pasition to render to his client. Obviously a factor is a Boulce of abort term money, but because of the continuing nature of the financing does release funds for other uses. When stock is to be sold, it is frequently sold locally, but sales may be to persons other than personal friends. The stock may have distribution in a county or state; it may be preferred or common. .4 company of any magnitude that appears to have promise of is an object of considerable interest to the more alert future suand aggressive members of the financial fraternity. Such a cow pany will nsually be visited by the New Busineea Departments of more aggressive hanks and investment banking houses. The visitors will solicit accounts and offerhancial advice and various financial services, nsually with an ultimate fee or other reciprocity in mind. If immediate business is not forthcoming, at least friendly, personal relations may ensue. The alert financial officer of B small growing concern, with the many contacts he can build up over the years, can be of tremendous assistance to his wm-
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Within relatively recent years, several enterprim have bean organised which have equity wpital (usually supplied by stockholders or partners) to invest. Them capital pools have as their purpose securing long term capital gains on their investments. Generally speaking they are in a p i t i o n to supply equity funds to small and intermediate sized corporations for expansion and other purpases. Briefly, they operate as follows: They will buy 60% (usually at least a majority interest) of the stock of a company on the basis of the book value of the company’s aasets. The plan, after 6 months, is to resell the stock to the public at a higher price than they paid for it, usually on a capitalised e m ioga basis. Subh operations are sometimes very profitable. Examples of this type of financing are the dealings of J. H. Whie ncy and Co. and Spencer Chemical after World War 11. Small established companies can frepuently atEliate with larger companies in order to 6nnnce large sums. There havebean many such &iationa ranging from complete mergers to “advanma from customers.” Frequently, too, a small, established concern
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can get aasistane from the Government either in the form of direct loans or contracts which can serve as the basis of loans or advances from others or for direct advances from the m.. Government on g o v e r n m e n t contracts (1). Today, many small and intermediate sise concern are leaning heavily on government research contracts. A situation which is common to numy small concerns and even to some large concerns is the maintenance of continuity of o &io and mansaement on the death of a sole owner or major hoider. &tat;: taxes are high, and it is often impaesibie to pass on to the heire of a major stockholder enough ahares to control the company. While the permutations and combinations of possibilities is far beyond the mope of this paper, the subject is introduced simply because the situation is one of common occurrence today and is one that is often a major consideration in the sised companies, whether the financing of small to in-ate avowed object of the financing is for a new development or smne other purpose. Any speci6c financing must be viewed in terms of a multiplicity of factors. Large, well established companies requiring large m o u n t s of money may follow several routm in its financing. Du Pont, for example, in recent years hae been using ita own funds. Without doubt, much of industry’s expansion has been accomplished with retained earnings (SI. When large companies go outside for money they invariably have to operate on a national male. Companies rarely sell stocks or bonds directly t o the public, but sell to investment e w act banking houses or syndicates of such houses, who in a s ae wholesalers and secum through their many outlets (brokerage houses, banks, etc.), a retail dktribntion. Large oompaniea may aLM bomw directly from a bank or group of banks or may borrow directly from such large institutional lenders as truat companies and insurance companies. An an example which well illustrates thevarious ways companies get money, let us consider the financial history of the Dow Chemical Co. (3,8). _I
1. The Canton Chemical Go. was formed in 1889. This was a partnership, consisting of Dow and Joseph P. Smth, a Cleveland egg merchant. Later two more partners were included-Jacob Miller and J. A. Linville of the Buckeye Mower and Reaper Co. of Canton. Apparently the arrangement was for Dow to do the work while the partners supplied the money. The partnership dissolved in about a year, the venture appre+.Iy unsuccessful. 2. Midland Chemical Co. was or w e d LO 1890. DOWborrowed a few thousand dollars from J.%. Osborn. I n 1891, W. L. Hulburt and B. H. Howe were pemaded to put np a little money in return for admiasion into the partnership. The company was incorporated in 1892,and $100,000 dollars was promised the company by a group of local business men, but only $27,500 came in. A Cleveland bank granted credit of $10,000. The venture was apparently successful, but Dow left for greener pastures. 3. Dow then formed the Dow Process Co. Dow and four partners put up respectively S.%XW; $5333.33; W333.33: WCO; and 52ooo. The venture apparently was succeaful. Until this point, Dow, referring to the enterprise, might be called a new, small company. It now becomes what the writer has termed a small, established enterprise. 4. In 1897 the present Dow Chemical Co.was organised. It was financed by the sale of 20,000 shares of $10 par value stock. In March 1900 10,928shares were sold for $109,260cash; 10,400 shares were issued to purchase the Dow Process Co.; and 30,000 s h e s were lssued in August ls00 t o purchase the Midland Chemical Co. In June 1901,15,000shares were sold for $15o,ooO cash; 11,500shares in February I902 for $115,000 caah; Boo0 shares in September 1803 for $48,000cash; and 24,000shares in Msy 1804 for $192,000 rash.
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5. B 1932 the company had outstending a 7% cumulative p r e f d stock (15,000 nharrs) and a common stock (15,000 nharea). Between 19!22and 1930 more preferred and more common were issued. In 1830 the com y borrowed W,5Op,oOO on notes bearing an interest rate of B r a n d having a nmkmg fund which would redeem 66% of the issue in 10 yeam, more Dommoll we4 anth0ri.ed. 6. In 1935, D?w b w d (3,eoO,000 a t a’/*% using Berial notas, from f i n a n d institutions to p y oh w h t was left of the 6% debt and for “ a d d i t i ~ to~ lant. In 1838 a 5%cumulative referred was k e d and the 7% cumulative preferred was d e d Sy the company for redemption a t a price of $106 er -e 7. .On Deosmbsr 1,1936, ip order to obtain fun% for the’constru&on of p l ~ t and s buildmge, Dow sold $5 000,000 worth of debenture bonds bearing an interest rate of 3%. In 1940, the com any’s balance sheet revealed it owed $4,a.zoO 000 wbich it had\orrowed from banks. In the ~ y u a eyear it sold more debenture bonds ($7,600,000) bearing an intereat rate of 2*/& for the purpaea of redeermng the 3’s and other corporate purposes, and also sold enme (S7,600,000)ssrial debenturea.bearing interest rata from 0.36 to 2.00% the low mtareet bang on the short matnritiea. 8. In 1944 the company hsd “notes payable to banks” of Sl,p,000; owed $7 600,oOO on the Z 1 / h and $5,250 000 on the m d d e h t u r e s . A 4% cumulatave preferreerred was’iasued and the 5% prefer4 was d e d . In that year it had outstanding l,?48,700 shnrss of common out of Z,oOO,000 h which the company had been authorlred by its board of directom to issue. 9. In 1945 the company paid off all ita debt, and in 1946 sold %30,000,000 of debenture bonds (15 yeam, 2.35% and borrowed 000 from an inaurana company a t 2.702. 10. in 1948 the cornpan h e d a (3.25 (annual dividend) convertible preferred stock., suthoriaed 12,000,000 sham of common stock,and had outstanding 4,884,824 shares which by ootober ai, 1850, hsd into 6,084,751sharee.
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And en Dow’s financiug wtinuea Lest year the company to b o r n up to $90,8o,ooo,oOO from inaursnce corn psniea on 3’/4% promiemryn o t a This yesr Dow plana an isaue of $100,000,000 convertible deben-. amanged
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That Don haa done a great deal of “financing” via the retained eamiugn ronte is obvious from au ewmination of the company’s balance sheets. In 10% surplus in given fa $4,4313,637. In 1 8 w earned surplus a t tbe company‘s year end (May 31) waa
$50,eSo80l4. That b r i d y in Dow’s h h g . The record of Dow’a many teohnid developmenti in too well h o r n to go into here. From its lirat-the development of techniquea for the exhotion of bromine and chlorine from brinea. to magneaium and plastiabita record in one of outatanding achievement and en in the record of the company’s financial and business operations. In Dow, as in any business, all facets must be brilliant. All pnrts must interlock and mesh together in ordm for the enterpriw to be a mccess.
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LITERATURE CITED (1) Bollinger, L. I., “Financing Defenae Orders,” New York. McGraw-Hill Book Co., 1941. (2) Calhoun. D. R.. Jr.. C h .Ew. Nnoa, 28,3674 (ISM)). (3) Campbell. M., and Hutton, H.. “Herbert H.Dor,” New York. Appleton-Centw-Croftq 1961. (4) Dunwoody, R.. Cham. Ew.N m ,28.4538 (18w). (5) Lanner. J. E.,“How to Run a 8 d l Bluine~,”New York. MoGraw-Hill Book Co.. 18.54. (6) Lub, F. A.. and Lutr. V. C.. “Theory of Investment of the Firm,” Rmceton, N. J.. Rinoeton Univemity h. 1961. (7) Mace, M. L.,“The Board of Diraotors in 8 4 Corporatione,” P. 8. Graduate &hcd of Buainess Adminimstion, Harwrd University.11848. ( 8 ) Porter. 8. J. (editor-in-chief). “Ma&s Msnusl of Inwitmente-Induntrial8eaurities.” New York, Mwdy‘a Inveatom Eervics, varioua years. (9)Sermritiea and Exchange Commission. Washington, D. C.. “ M o m t o Chemical Co.. Report for the Month of June 1951,“ 1951. (10) 8essel. B.. Cham. Ew.N m q 28, 4338 (1960).
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Rmomrvmo for review %pmrnh 16, 1952.
Accimmn Daoembsr 10. 1952.
‘l’ransportation s h i p m d b.rg. deniun for both drp and l i p i d chemical. in bulk h~ udargad the usefulnun of watmwam which carm th. trltata ~a extendvdy. Competition of dl the truuport.tion facilities. plus continually rising 0ating costs,hu pF0mot.d technologid impmvementa h railmad opaution and mad &IM. Intarmi- road buiiding L encouraging decentrollaton and location of .mall industha away fmm congested oity MIU. A ncently & w t h e e m of uniform height rates L expected to b d down territorial barriers and eIuxIulongdistance rail h i g h t mw-snb.
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FLANSPORTATION, fa it relates to the ares comprising New York, New Jemy, and Pennnylvania, haa bsen built into the needs of the region over a period of enme 100 yearn, bginning with the digging of csnals in the statm of Pennsylvania, New York,and Marylsnd. Before the raiL0.4~were built the waterway off& a smooth road with little cost of maintenancefor the encouragement of trade and travel. The natural waterway provided the cheapest “highway”; tbe man-made waterway, with I&, w88 the next bent. Thia held true until the develop me& of the railroad made possible better transportation than the waterway could provide, with the additional advantage of mperiorsersiaa.
WATERWAYS The waterway, on the other hand, even after the coming of the railroadn, never lost ita important place in the transportationfield. As far as the trbhate ares under consideration in concerned, the O r a t h k e a provide a freeand open waterway for six months of the year for the movement of huge quantitiea of raw materids between the upper and lower ends of the lakes and through tbe inland waterway system. The Atlantic Ocean and ita tribuMea, the Delaware River, Chesapeske Bay, and Hudson Rim, provide tramporhtion throughout the cosstal arean. The Ohio River and ita tributaries, reaching into Pennsylvania, provide a long waterway from the gulf to the Pittsburgh area and fmm the Pittsburgh area through the Ohio River and its tributaries into the midwestem states and Weat Virginia Today a tnunendous volume of freight movm through the Ohio River and ita tributariea between the Pittsburgh ares and chemical plants in Went VirPinia, Ohio, Kentucky, and all the way down to Memphis and New Orlaum; ana, on the inwaatal waterway, saat to Mobile and nest to the Lake Charles, Port Arthur,and Galventon Bsrge transportation in a d able all the way from the Mexican border, a t Brownmille, Tex., to the weatern portion of Pennsylvania. In the pent, the New York State Barge Canal connenting the Hudson River with BuEalo provided a channel for the inbrchan@
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