The term residual value, or RV, refers to one of several factors used in lease calculations. It is the residual, or remaining, value of the leased asset at the end of the lease agreement. In a closed end lease or open end lease, the estimated residual value is used to calculate the monthly lease payment.
Residual Value = Initial Value of Asset – Loss in Value
- Loss in Value = Expected depreciation of asset over the term of the lease
Often used in car leases, the monthly lease payment on any asset needs to include the lost value plus interest expenses and fees. This is sometimes referred to as the net capitalized cost.
The residual value of an automobile is calculated using an assumption for the number of miles driven during the lease term. If the car has higher mileage than allowed, a mileage charge may apply.
Many luxury cars are very popular with consumers as used cars; therefore, market demand keeps their price relatively high. This relatively small loss in value results in a relatively high residual value; thereby lowering lease costs. This is the reason some luxury vehicles have attractive monthly lease payments.
Finally, since the lease payments were based on an estimated residual value, it is also the price at which the leaseholder can purchase the car at the end of a lease.
A car is worth $25,000 when new, and at the end of a three year lease, the vehicle is expected to lose $10,000 in value. The residual value of the car would be:
= $25,000 – $10,000, or $15,000