Final answer:
Depreciation expense is not a direct cash flow item but it impacts cash flow by reducing taxable income, which in turn lowers the income taxes paid by a business. This indirect effect on cash flow is important for valuation and forecasting models. The correct option is B.
Step-by-step explanation:
Depreciation expense is indeed not a cash flow item; it is an accounting method to allocate the cost of a tangible asset over its useful life. However, depreciation affects cash flow indirectly. The correct answer to the question is B. income taxes.
When calculating taxable income, depreciation is considered an expense, reducing the profit, which in turn reduces the income tax that a business must pay.
Therefore, while depreciation does not involve the outflow of cash, its effect on reducing taxable income leads to a cash flow advantage because of the lower income taxes paid. This is an important consideration in cash flow forecasting and valuation models. The correct option is B.