The residual value of an asset (its resale or salvage value at the end of the project) is treated as an  additional incoming cash flow in the final year of the project.

Here are the detailed steps to properly integrate it into the calculation of the Net Present Value (NPV):

1. Integration with the latest Cash Flow

The residual value is not subtracted from the initial investment, but is added to the last operating cash flow (in year n). It should be seen as a real inflow of funds that increases the wealth created by the project.

2. Tax treatment (Capital gains tax)

The crucial point is to calculate the residual value net of tax. Indeed, the resale of the asset can generate a taxable capital gain if the sale price is higher than its net book value (NAV).

The calculation is done as follows:

1. Calculation of the capital gain: Capital gain = Sale price – Net Book Value (NBV)
2. Calculation of the net flow: Net flow = Sale price – Capital gain × Tax  rate

Be careful, the tax rate on capital gains may be different from the tax rate on operating profits. In addition, if the project generates a capital loss on the sale, it can be used to save the tax that would have been generated by another sale carried out in the company and which would have generated a capital gain of the same amount or a greater amount.

3. The impact of the depreciation method

The amount of the tax depends on the depreciation policy adopted during the life of the investment project:

• Unsecured residual value (most common): The company generally depreciates the entire asset over its lifetime. The NBV is therefore zero (0) at the end. Therefore, the entire resale price constitutes a taxable capital gain.
• Case of the certain residual value (or guaranteed): If the resale value is guaranteed (e.g. take-back contract by the supplier), the company must only amortize the difference between the purchase cost and this residual value. At the end, the NBV is equal to the sale price. There is therefore no capital gain or tax to pay at the end. In return, the company benefited from fewer tax savings on depreciation during the life of the project (lower depreciable base).

4. Updating and sensitivity

Like any future flow, this net amount must be discounted to the Weighted Average Cost of Capital (WACC) to its value at date 0. It should be noted that, due to discounting (especially for long-term projects), the residual value often has a marginal  impact on the overall NPV. It is often considered a “risky but not sensitive” parameter in sensitivity analysis: even if its value varies, it rarely changes the investment decision.