"Dieser Apfel ist schlecht."
Yes, there is a difference. <diese> ['di:zə] und <dieser> ['di:zɐ] http://en.wikipedia.org/wiki/International_Phonetic_Alphabet#Vowels
Either "rancid" or "bad" in the sense of "unsuited for". If you have a basket and you want to put fruits in i as decoration and this one apple youldn't look good in it, you could say "Dieser Apfel ist schlecht." But generlly speaking, "schlecht" emans "rancid". If you want to say "it tastes bad" that would be "Er schmeckt schlecht".
Apfel is masculine, so I'm guessing that's why the "Er". The context of the conversation would tell you the speaker was referring to the apple. But you're right, as a standalone sentence it's annoyingly misleading. I think the Germans really missed the boat during their language reforms several years back by not assigning neutral genders to all inanimate objects!