Why is depreciation added back when getting to net incremental cash flows?
a) Adding back depreciation to get to net incremental cash flows is required by accounting rules. For practical purposes, it is a meaningless step.
b) Depreciation is an important accounting expense, but it does not involve any cash. Since operating income on the income statement has been reduced by the amount of depreciation, it must be added back in order to get close to actual cash.
c) Depreciation is considered a cash item only on the balance sheet. Since getting to cash flow for capital budgeting starts with operating income on the income statement, depreciation must be added back.