debentures were secured by a trust agreement, dated as of July 1, 1929, which petitioner, on August 21, 1929, also executed in favor of the Continental National Bank & Trust Company, trustee.

On July 1, 1937, petitioner called and redeemed all outstanding debentures issued under the trust agreement with the Continental Illinois Bank & Trust Company, trustee, dated July 1, 1929.

On October 21, 1938, petitioner borrowed $1,500,000 from the Bank of The Manhattan Company of New York. This indebtedness was evidenced by its promissory note for that sum payable in 5 installments of $300,000 each, maturing November 30 of each year beginning with November 30, 1939, with interest at 234 per cent per annum, and subject to a note agreement which the parties entered into contemporaneously therewith. This money was borrowed to pay off bonds issued at a higher rate of interest.

On October 31, 1938, petitioner called for redemption and payment on December 1, 1938, all outstanding bonds issued under the indenture of mortgage and deed of trust dated June 1, 1926, and supplemental indenture of mortgage and deed of trust of June 1, 1929.

On December 1, 1938, petitioner paid and redeemed all of the bonds in accordance with its call.

The particulars of borrowed capital during the base period years are as follows:

BORROWED CAPITAL-YEARS 1936-1939

As a result of the above mentioned financial changes, during and prior to the base period, petitioner's change in ratio of nonborrowed capital to total capital is indicated by the following table:

The interest paid on the above borrowed capital and the amount of amortization of discount and expense (exclusive of discount and expense on bonds retired) deducted in petitioner's income tax returns and allowed by respondent for the years 1936, 1937, 1938, and 1939 are as follows:

The following table reflects the extent to which petitioner is entitled to an adjustment in its interest deduction for the base period. under section 722 (b) (4):

At all times prior to and during the base period years, petitioner engaged in the business of manufacturing and selling unbleached kraft bag and wrapping paper, corrugating material, and container board, which it manufactured at its mill at West Monroe, Louisiana, from southern pine wood by the sulphate process.

During the base period years and those here involved, petitioner obtained its supplies of pine wood for pulp from forests located in the States of Arkansas, Louisiana, and Mississippi.

Sulphate or kraft pulp is made by a process developed from the soda process in 1883 and first used in the United States about 1907. The sulphate process is adapted to pulping most species of wood, including resinous coniferous woods, for which the sulphite and soda processes are not generally employed. The sulphate process is used chiefly for pulping southern pine and jack pine, and to some extent hemlock, balsam fir, Douglas fir, and spruce.

An expansion in kraft production in the South occurred during the years 1936, 1937, and 1938. In 1936 one additional sulphate paper and board mill went into operation. Eleven additional sulphate pulp, paper, and board mills went into operation in the years 1937 and 1938.

The construction of new kraft mills in 1936 to 1939 was not a temporary condition. A paper mill is permanent, requiring a large investment, and once set up is intended to last a long time.

The growth in the capacity to produce paper and paperboard during the years 1936 to 1939 was not unusual in the history of the paper industry. The growth in the total capacity of paper machines, which is the best measure of capacity, during the period 1935 to 1939 was approximately 22 million tons. Percentagewise this was not an extraordinary growth for a 4-year period. Several other 4-year periods were greater or nearly equal. 1909 to 1914 shows a greater percentage gain than shown in the period 1935 to 1939. The growth in capacity for production of paper and paperboard during the period 1936 to 1939 was about normal.

The base period expansion in bag and wrapping paper production capacity was not an extraordinary expansion. During the years 1925 to 1929 expansion in wrapping paper and bag production was 24.9 per cent while during the base period it was 26.9 per cent. In paperboard production (capacity) the expansion from 1925 to 1929 was 29 per cent and in the base period it was 27 per cent.

Kraft test liner prices, per ton, in the New York territory, by months, with respect to the years 1936, 1937, 1938, and 1939, were as follows:

The wholesale price index for all commodities during the years 1936, 1937, 1938, and 1939, expressed by means of an index with the year 1926 100, discloses the following:

1936.

1937.

1938_.

1939_.

80.8

86.3

78.6

77.1

During this period the price of the finished fabricated shipping container that the container manufacturer was producing and selling did not decrease accordingly.

The converters who were converting sulphate board into boxes added to their equipment in 1938 and 1939. Also, new fabricators built plants. These additional production facilities of the fabricators came in a year or less. During the period of 1937 to 1939 the converters were taking on more kraft products than they had in the earlier period. The entire growth of kraft paperboard production was continuing.

A comparison of the Federal Reserve indices of industrial production, petitioner's combined production, and sulphate pulp production, during the period from 1927 through 1939, expressed by index numbers with 1935-39 average=100, shows that sulphate pulp production had a generally steady growth with minor exceptions in 1934. It also shows that petitioner's combined production grew rapidly with a minor decline in 1938. Contrasted with these, industrial production in general shows some decided variations. In 1938, the industrial production generally fell off decidedly more than did that of petitioner, and in contrast to sulphate pulp production which showed a decided growth.

A comparison of industrial production in general, mill production of kraft liners and corrugated board, in tons, kraft paper total production, in tons, and petitioner's combined production, in tons, for the years 1936, 1937, 1938, and 1939, expressed by index numbers with 1935-39 average=100, discloses an increase in mill production of kraft liners and corrugating boards from 85 in 1936 to 140 in 1939. The increase in mill production of kraft liners and corrugating boards, as aforesaid, was fairly steady.

A comparison of the relationship of average monthly production to new orders and unfilled orders of paperboard generally emphasizes the close relationship that exists between new orders and production. Petitioner's industry does not accumulate large inventories. New orders and production move hand in hand. In 1938, unfilled orders were down to a negligible level.

Paper machines can produce more paperboard than wrapping paper or bag paper.

One measure of a paper machine's capacity is its drying capacity. The installation of additional dryers would increase the production of a paper machine. If there is sufficient drying capacity, the speed of the machine or the weight of the product manufactured would govern its production.

In making paper, a paper machine rarely runs to its full drying capacity, and, on a very light weight of paper, the machine cannot be run fast enough to overtax the drier. But in making board, the paper machine is usually run to its full drying capacity.

A machine has unused capacity if the reason for the lost time is because there is nothing for it to make.

The amount of kilowatt hours of power required to manufacture paper varies from that required to manufacture board. For the years 1936 to 1939, it took about 1/10 times as much power to refine paper as it did to refine board.

Direct labor costs of petitioner in the base period years were as follows:

In 1939, petitioner discontinued the Swenson type washer and placed into operation 5 McDonald dehydrators. Petitioner was the first mill to install McDonald dehydrators. They were installed at intervals during the period from January to July 1939. The McDonald dehydrator is a pressure type washer. It is named after its inventor, Manuel C. McDonald, a former vice president and general manager of petitioner. Petitioner paid all costs for experimenting and building the McDonald dehydrator.

The McDonald dehydrator is different in method from any other process of pulp washing.

The McDonald dehydrator enabled petitioner to increase its chemical savings considerably. It enabled petitioner to save a great deal of sodium sulphate, which is the primary chemical used in the sulphate process.

Rosin is used in the manufacture of pulp and paper as a sizing agent to give the paper and board the degree of waterproofing that is desired. Rosin is the sticky substance found in the rosin ducts of the pines and certain softwoods. Alum is used in the manufacture of pulp and

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