Final answer:
Depreciation is added back to net income when calculating cash flow due to its non-cash nature, then subtracted for tax purposes to lower taxable income and subsequently subtracted in the free cash flow calculation.
Step-by-step explanation:
The statement that depreciation must be added to the cash flow in each year to calculate taxes for that year, but then must be subtracted because it is not actually a cash flow in that year, is true. Depreciation is a non-cash expense that reduces taxable income.
Therefore, it must be added back to net income to calculate the actual cash flow from operations since it did not reduce the company's cash balance. However, for tax purposes, depreciation is deducted because it is a permissible non-cash expense that lowers taxable income, hence decreasing the amount of tax payable. After accounting for taxes, depreciation is subtracted out in the calculation of the free cash flow because even though it provides a tax shield, it is not a cash outlay.