PROBLEM 4-12. Operating Leverage Sercon, Inc. and Zercon, Inc. are two companies in the pharmaceutical industry. Sercon has relatively high fixed costs related to research and development. Zercon, on the other hand, does little research and development.

Instead, the company pays for the right to produce and market drugs that have been developed by other companies. The amount paid is a percent of sales. Thus, Zercon has relatively high variable costs and relatively low fixed costs.

Sercon, Inc. Zercon, Inc.

Sales $80,000,000 $80,000,000 Less variable costs 20,000,000 50,000,000 Less fixed costs 50,000,000 20,000,000 Profit $10,000,000 $10,000,000 Required

a. Which company has the highest operating leverage?

b. Calculate the expected percentage change in profit for a 10 percent increase (and for a 10 percent decrease) in sales for each company.

c. Which company is more risky?