Zelnor, Inc., is an all-equity firm with 100 million shares outstanding currently trading for $8.50 per share. Suppose Zelnor decides to grant a total of 10 million new shares to employees as part of a new compensation plan. The firm argues that this new compensation plan will motivate employees and is better than giving salary bonuses because it will not cost the firm anything. Assume perfect capital markets.
a. If the new compensation plan has no effect on the value of Zelnor's assets, what will be the share price of the stock once this plan is implemented?
b. What is the cost of this plan for Zelnor investors? Why is issuing equity costly in this case?