Financial valuation of production diversification in the steel industry using real option theory

Abstract

Steel industry is subject to significant volatility in its output prices and market demands for different ranges of products. Therefore, it is common practice to invest in various assets, which gives the opportunity to diversify production and generate valuable switch options. This article investigates the incremental benefit of product switch options in steel plant projects. The options are valued using Monte Carlo simulation and modeling the prices of and demand for steel products as Geometric Brownian Motion (GBM). Our results show that the product switch option can generate a significant increase in the net present value (NPV) of metallurgical projects.