Zelnor, Inc., is an all-equity firm with 120 million shares outstanding currentl
ID: 2620065 • Letter: Z
Question
Zelnor, Inc., is an all-equity firm with 120 million shares outstanding currently trading for $8.37 per share. Suppose Zelnor decides to grant a total of 12 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? 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? If the new compensation plan has no effect on the value of Zelnor's assets, the new share price will be S (Round to the nearest cent.) b. What is the cost of this plan for Zelnor investors? Why is issuing equity costly in this case? The cost to investors is S million. (Round to the nearest million) Why is issuing equity costly in this case? (Select the best choice below.) OA. It only appears costly-the value of the firm as a whole is unchanged. O B. It is not costly because we are not taking into account the benefit of the equity to the employees. Once that is accounted for, the value of the firm will be the same. O C. This is a standard example of the effect of dilution on the share price which is always costly 0 D. It's costly because the shareholder equity is being given away to employees for free Click to select your answer(s).Explanation / Answer
(a) Number of Outstanding Shares = 120 million, Current Share Price = $ 8.37
Asset Value = Total Market Capitalization = 120 x 8.37 = $ 1004.4 million
As the asset value remains the same, the total firm value will continue to be $ 1004.4 million
New Shares Issued = 12 million
Total Number of Shares Outstanding post issue = 120 + 12 = 132 million
New Share Price = 1004.4 / 132 = $ 7.61
(b) As the share price undergoes dilution, the difference between the pre-issue and post-issue price is the cost borne by investors.
Cost to Investors = (8.37 - 7.61) x 120 = $ 91.2 million
The share issue is costly as the equity is being given away for free from the employees' perspective but the actual cost is being borne by the firm's existing shareholders. Hence, the correct option is (D).
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