Chartered Financial Analyst Level 2

Explanation

Special cash dividends and share repurchases are the most appropriate payout methods for distributing extraordinary increases in cash flow that are not expected to continue in future years.

Why Option B is Correct:

1. Special Cash Dividends: These are one-time payments that explicitly signal to investors that the dividend is not expected to be repeated. They are ideal for distributing temporary cash windfalls without creating expectations for future payouts.

2. Share Repurchases: Companies can use excess cash to buy back shares, which is flexible and doesn't create ongoing commitments. Unlike regular dividends, repurchases don't establish a recurring payment expectation.

Why Other Options Are Incorrect:

• Option A (Regular and special cash dividends): Regular dividends create an expectation of continuity and should be used for sustainable cash flows, not temporary windfalls.

• Option C (Regular cash dividends and share repurchases): Regular dividends are inappropriate for temporary cash increases as they signal ongoing commitment, which would be misleading if the cash flow is not sustainable.

Key Concept:

Companies should match payout methods with the nature of their cash flows:

• Regular dividends for stable, recurring cash flows
• Special dividends/repurchases for temporary, non-recurring cash windfalls

This approach maintains dividend policy credibility and avoids setting unrealistic investor expectations.