Now let’s go out 1 year, to the start of Year 2. Assume the debt is high-yield so no principal is paid off, and assume an interest rate of 10%. Also assume the factories depreciate at a rate of 10% per year. What happens?

After a year has passed, Apple must pay interest expense and must record the depreciation.

Operating Income would decrease by $10 due to the 10% depreciation charge each year, and the $10 in additional Interest Expense would decrease the Pre-Tax Income by $20 altogether ($10 from the depreciation and $10 from Interest Expense).

Assuming a tax rate of 40%, Net Income would fall by $12.

On the Cash Flow Statement, Net Income at the top is down by $12. Depreciation is a non-cash expense, so you add it back and the end result is that Cash Flow from Operations is down by $2.

That’s the only change on the Cash Flow Statement, so overall Cash is down by $2.

On the Balance Sheet, under Assets, Cash is down by $2 and PP&E is down by $10 due to the depreciation, so overall Assets are down by $12

On the other side, since Net Income was down by $12, Shareholders’ Equity is also down by $12 and both sides balance.

Remember, the debt number under Liabilities does not change since we’ve assumed none of the debt is actually paid back.