The officers of Environmental, Inc., considered themselves fortunate when the company sold a $9,000,000 subordinated convertible debenture issue on June 30, Year 1, with a 6% coupon. They had the alternative of refunding and enlarging the outstanding term loan, but the interest cost would have been one-half point above the AA bond rate. The AA bond rate was as high as 81 2%until March 29, Year 1, when it was lowered to 8%, the rate that prevailed until September 21,Year 1, when it was lowered again to 71 2%. As of December 31, Year 1, Environmental, Inc., had the following capital structure:

7% term loan* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,000,000

6% convertible subordinated debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000,000

Common stock, $1 par, authorized 2,000,000 shares, issued and outstanding . . . 900,000

900,000 warrants, expiring July 1, Year 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500,000

*Term loan (originally $5,000,000) is repayable in semiannual installments of $500,000.

Convertible subordinated debentures sold June 30, Year 1, are convertible any time at $18 until maturity. Sinking fund of $300,000 per year to start in Year 6.

Warrants entitle holder to purchase one share for $10 to expiration on July 1, Year 6.

Additional data for Year 1:

Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 500,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 1,500,000

Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 135,000

Earnings retained. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 900,000

Market prices December 31, Year 1 (averages for Year 1)

Convertible debentures 6% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. $107

Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . $ 13

Stock warrants. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . $ 4.5

Treasury bills interest rate at 12/31/Year 1 . . . . . . . . . . . . . . . . . . . . . . . . . . .. 6%

Required:

a. Calculate and show computations for basic and diluted earnings per share figures for common stock for the Year 1 annual report (assume a 50% tax rate).

b. What is the times-interest-earned ratio for Year 2 assuming net income before interest and taxes is the same as in Year 1 (a 50% income tax rate applies)?