residual value risk (1)

with an ordinary loan or finance lease ,the size of repayments \rentals is determined by a mixture of the capital amount\cost of the asset and funding cost/credit risk margin .With an operating lease there is an additional variable ,the residual value .The rental in an operating lease takes account of the funding cost and credit risk margin but the cost of the asset ,or capital amount to be "repaid" (in reality the extent to which the depreciation in the value of the asset has to be covered in the rental) is reduced by the assumed residual value of the asset at the end of the lease period .The higher the assumed residual value ,the lower the capital element and the lower the rental .
In a competitive scenario ,this means that there is pressure to set aggressive residual values in order to win business .setting residual values is not a simple task anyway-looking forward two ,three,five or perhaps more years and predicting the second hand value of apiece of equipment is a difficult Job .some of the generic factors that have to be taken into account are :
- the likely rate of inflation ;
- likely exchange rate movements if the asset is sourced from overseas;
- how specialized the asset is-how limited a market will it be sold into;
- the rate of technological change - computers that are state of the art now soon become entirely obsolete if they cannot be upgraded ;
- how will the asset be used ? an asset that is run into the ground will not be an attractive sale proposition ;
- potential for legislative or regulatory changes that would impact on the asset-change to environmental standard could make a non-compliant asset unsaleable .