Loading the player...

What is the 'Residual Value'

The residual value of a fixed asset is an estimate of how much it will be worth at the end of its lease, or at the end of its useful life. The lessor uses residual value as one of its primary methods for determining how much the lessee pays in lease payments. As a general rule, the longer the useful life or lease period of an asset, the lower its residual value.

BREAKING DOWN 'Residual Value'

If you lease a car for three years, its residual value is how much it is worth after three years. The residual value is determined by the bank that issues the lease before the lease begins. It is based on past models and future predictions. Along with interest rate and tax, residual value is an important factor in determining the car's monthly lease payments. In capital budgeting projects, residual values reflect how much you can sell the asset for after the firm has finished using it or once the asset-generated cash flows can no longer be accurately forecast.

Uses of Residual Value

An example for a business owner would be if his desk had a useful life of seven years. How much the desk is worth at the end of seven years (its fair market value as determined by agreement or appraisal) is its residual value, also known as salvage value. To manage asset-value risk, companies that have numerous expensive fixed assets, such as machine tools, vehicles or medical equipment, may purchase residual value insurance to guarantee the value of properly maintained assets at the ends of their useful lives.

Calculating Depreciation/Amortization Using Residual Value

Residual value also figures into a company's calculation of depreciation or amortization. Suppose a company acquires a new software program to track sales orders internally, and this software has an initial value of $10,000 and a useful life of 10 years. In order to calculate yearly amortization for accounting purposes, the owner needs the software's residual value, or what it is worth when those 10 years are up. Assume this value is zero and the company uses the straight-line method to amortize the software. Therefore, the company must subtract the residual value of zero from the $10,000 initial value and divide by the asset's useful life of 10 years to arrive at yearly amortization, which is $1,000.

For tangible assets, such as cars, computers and machinery, a business owner would use the same calculation, only instead of amortizing the asset over its useful life, he would depreciate it.

RELATED TERMS
  1. Residual Income

    The amount of income that an individual has after all personal ...
  2. Subvented Lease

    A type of lease where manufacturers will reduce the cost of the ...
  3. Residual Security

    A convertible security which may increase the number of current ...
  4. Walk-Away Lease

    A common type of car lease in which the lessee returns the car ...
  5. Open-End Lease

    A rental agreement that obliges the lessee (the person making ...
  6. Residual Interest

    1. A charge for borrowing money that accrues on a credit card ...
Related Articles
  1. Investing

    Explaining Residual Value

    Residual value is a measurement of how much a fixed asset is worth at the end of its lease, or at the end of its useful life.
  2. Investing

    Valuing A Company Using The Residual Income Method

    Learn the underlying basics behind the residual income model and how it can be used to place an absolute value on a firm.
  3. Investing

    Valuing A Company Using The Residual Income Method

    Residual income is the income a company generates after accounting for the true cost of its capital, which is the cost of funds it uses to finance its business.
  4. Investing

    Economic Value Added - EVA

    Learn about this metric that measures a company's financial performance based on its residual wealth.
  5. Managing Wealth

    What is a Capital Lease?

    A lease considered to have the economic characteristics of asset ownership.
  6. Investing

    New Wheels: Lease Or Buy?

    These two major ways to obtain a car have very different advantages and drawbacks. Find out which is best for you.
  7. Investing

    How Does an Operating Lease Work?

    Operating lease is a term used mostly in accounting to denote a lease that gives the lessee rights to use and operate an asset without ownership.
  8. Managing Wealth

    Your Lease Is Up: When Should You Buy The Car?

    In general, the fact that you know the car is to your benefit. Before deciding, compare the buyback price to what the car would go for on the open market.
  9. Personal Finance

    When Is Buying A Car Better Than Leasing?

    People who lease a car are often more concerned with the short-term picture.
  10. Managing Wealth

    4 Ways to Get the Best Deal on a Car Lease

    Car buyers typically negotiate when purchasing a vehicle, but many don't negotiate when leasing a car. There are several ways to save if you ask.
RELATED FAQS
  1. How is residual value of assets taxed?

    Find out how and when taxes are assessed on the different kinds of residual value, including the residual value on a leased ... Read Answer >>
  2. How is residual value of an asset determined?

    Understand what the residual value of an asset is and how the residual value of an asset is calculated. Learn how residual ... Read Answer >>
  3. What is the importance of residual value in an automobile lease?

    Find out how dealerships assign residual value and why this is an important factor in car leases. Learn about a tactic some ... Read Answer >>
  4. What is the difference between terminal value and residual value?

    Read a brief overview of residual value and terminal value, two near-identical terms that refer to the future value of a ... Read Answer >>
  5. Is residual income considered profit?

    Understand what residual income is and under what circumstances it may be considered profit. Learn how this can benefit personal ... Read Answer >>
  6. What is the difference between residual income and operational income?

    Understand the key factors that go into calculating operational and residual income, as well as what each of these categories ... Read Answer >>
Hot Definitions
  1. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  2. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  3. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  4. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  5. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  6. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
Trading Center