Except for land, all other nonmonetary fixed assets like building, machinery etc have a limited life period (called service life) after which these assets provide no economic benefits to a company. Thus by selling these assets, the company would have a cash inflow. This selling price is nothing but a residual value of that asset.
Residual Value = Original Cost – Depreciation Expense X Service Life
e.g.) Suppose a company buys a machinery at a cost of $40000. Let it has a service life of 10 years. If the yearly depreciation cost is $3000, the residual value of the machinery after 10 years would be $10000 (as per the above formula).
If the residual value is very small and realized in a far future, it is neglected. However, residual value holds importance in decision making if it is significant and generates considerable cash inflow.
The residual value helps us to find the net cost of an asset which is given by: