Definition: The residual value, sometimes called salvage value, is an estimate of the monetary value that an asset will have after its useful life has ended. In other words, it’s the final price an asset is worth after it is completely used up.
What Does Residual Value Mean?
What is the definition of residual value? In accounting, this concept is regularly used to calculate an asset’s depreciation expense. Since this is the ending value of the asset, it must be deducted from the purchase price to find the total amount able to be depreciated. Under the straight-line method, this number is then divided by the useful life in years to arrive at the annual depreciation expense recorded each year. This concept is also used regularly in valuation procedures.
In finance, salvage value is used to determine the value of the cash flows generated by a company after the time horizon used for the forecast. If a forecast is projected for 10 years, assuming the company will remain operational, the cash flows projected for the remaining years must be valued. In this case, they will be discounted to get their net present value and added to the market valuation of the project or company.
Let’s look at a simple example.
Example
Private Jets, LLC is a company that leases airplanes to high-income individuals. Airplanes are bought by Private Jets and leased for a monthly fee after negotiating the conditions. The company is currently reviewing the formula they use to determine the lease price. Each jet costs $1M and has a useful life of 6 years according to the company. At the end of 6 years, the planes will be worth $400,000.
This means that the planes should be depreciated $100,000 each year over their 6-year useful lives. At the end of 6 years, the planes’ net book value will be equal to the salvage value.
Summary Definition
Define Residual Value: Residual value means the worth of an asset at the end of its useful life.
