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

    Residual income is the amount of net income generated in excess ...
  2. Minimum Lease Payments

    The minimum lease payment is the lowest amount that a lessee ...
  3. Abnormal Earnings Valuation Model

    The abnormal earnings valuation model is a method for determining ...
  4. Subvented Lease

    A subvented lease is a type of lease in which the entity offering ...
  5. Residual Interest

    Residual interest is interest that may accrue on an interest ...
  6. Lease Payments

    Lease payments are tied to the terms of different forms of leasing ...
Related Articles
  1. Personal Finance

    New Wheels: Lease or Buy?

    Buying or leasing a car both have advantages and drawbacks. Find out which is best for you.
  2. 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.
  3. 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.
  4. Personal Finance

    Make the Right Choice: Buying or Leasing a Car

    Ask yourself these questions before deciding between leasing or buying a car.
  5. Financial Advisor

    Is Texas Instruments a Good Value Play? (TXN)

    Find out whether investors and analysts believe that Texas Instruments would make a good value play at its current valuation, and learn more about its outlook.
  6. Insights

    5 Ways to Create Residual Income

    Here are 5 ways through which you can create residual streams of income.
  7. Personal Finance

    Wait on Buying a Pickup (F, GMC)

    Used car prices are dropping everywhere. But if you're in the market for a pickup truck, a good bargain is less of a guarantee – thanks to strong demand.
  8. Investing

    Learn The Lingo Of Private Equity Investing

    Because of the non-public nature of private equity, it can be difficult to the learn the lingo. We break it down here.
  9. Personal Finance

    Should You Buy or Lease a New Car?

    Deciding whether to lease or purchase a car depends on a number of factors.
  10. Investing

    What Is The Intrinsic Value Of A Stock?

    Intrinsic value reduces the subjective perception of a stock's value by analyzing its fundamentals.
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. What is the difference between residual income and passive income?

    Learn how passive income helps pay the bills with little work involved. Determine how residual income affects your ability ... Read Answer >>
  3. What's the difference between amortization and depreciation?

    Learn the difference between amortization, depreciation, and depletion and how companies use these accounting methods to ... Read Answer >>
Hot Definitions
  1. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  2. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  3. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  4. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  5. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  6. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
Trading Center