Residual Value Defined as How much a fixed asset is worth at the end of its lease, or at the end of its useful life. This definition is according to Investipedia. For purposes of understanding residual value in terms of the equipment lease, the anticipated value of the leased asset at the end of the term is what one should understand. It makes it easy to explain why residual value exists and how it affects the lease rate.
Suppose a 72 month lease of a steam shovel with a residual value of 30%. Realize that 30% is a hypothetical residual value defined as 30 percent of the steam shovel’s initial value. If the steam shovel initially costs $250,000.00 at the beginning of the lease, the residual value is $75,000 at lease end 72 months later.
Residual Value Indicates 2 very important things:
- how much it (steam shovel) could be purchased for at lease end = residual value ($75,000)
- The amount that will be financed by lease ($250,000-$75,000) = $175,000.00
Important Applied Knowledge to take from Residual Value Defined
The greater the residual value is, the lower the lease payment will be with respect to the purchase price. Items with low residual value are relatively expensive to lease. Essentially, the lessee uses up (leases) a higher percentage of the asset. In fact, the sum of the lease payments may be greater than the initial cost of the asset had it been purchased. This will not likely be true with high residual value assets. The shorter the lease is, the higher the residual will be. That is because it has more useful life remaining. The lease will always bear a higher payment for shorter terms. However the total sum of the payments will usually be less in a shorter term equipment lease.
Challenge: Ask your copier sales rep what the residual value of the lease is. I give a 95% probability he or she will not know the definition and will not know the residual value for a given lease. That is a red flag!