Final answer:
To compute the diluted earnings per share for Foyle, Inc., 588,000 shares should be used. This includes the original shares, the time-weighted additional shares issued mid-year, and the dilutive effect of stock options using the treasury stock method.
Step-by-step explanation:
The number of shares that should be used in computing diluted earnings per share for Foyle, Inc. for the year ended December 31, 2011, is 612,000 shares. This calculation includes the original 560,000 shares, the 40,000 additional shares issued on July 1, 2011, and the dilutive effect of the stock options. To determine the dilutive effect of the stock options, we use the treasury stock method which calculates the net increase in shares from the exercise of options. It involves two steps:
First, we calculate how many shares could be purchased at the average market price with the proceeds from the exercise of options (32,000 options × $15 = $480,000 proceeds; $480,000 / $20 market price = 24,000 shares).
Then, we subtract the shares that could be purchased from the number of options to find the additional shares that would be diluted (32,000 options - 24,000 shares purchased = 8,000 additional diluted shares).
Adding these additional shares to the base and the new shares issued we get 560,000 + 40,000 + 8,000 = 608,000 shares. However, since the 40,000 shares were issued on July 1, 2011, they were not outstanding for the entire year. A time-weighting factor must be applied to these shares. Since they were outstanding for 6 months of the year, we multiply the 40,000 by 1/2 to get 20,000 time-weighted shares.
Thus, the final calculation for diluted shares would be 560,000 base shares + 20,000 time-weighted new shares + 8,000 additional diluted shares = 588,000 shares.