Calculation Explanation

Let's calculate step by step:

Step 1: Calculate end-of-year AUM before fees

• Beginning AUM = $50 million
• Annual return before fees = 20%
• End-of-year AUM before fees = $50 million × (1 + 0.20) = $50 million × 1.20 = $60 million

Step 2: Calculate management fee

• Management fee = 2% of end-of-year AUM before fees
• Management fee = 2% × $60 million = 0.02 × $60 million = $1.20 million

Step 3: Calculate return net of management fees

• Return before fees = $60 million - $50 million = $10 million
• Return net of management fees = $10 million - $1.20 million = $8.80 million

Step 4: Calculate incentive fee

• Incentive fee = 20% of return net of management fees
• Incentive fee = 20% × $8.80 million = 0.20 × $8.80 million = $1.76 million

Step 5: Calculate total fees

• Total fees = Management fee + Incentive fee
• Total fees = $1.20 million + $1.76 million = $2.96 million

Verification:

• Option A ($2.80 million) is incorrect - this might come from miscalculating incentive fee on gross return
• Option B ($2.96 million) is correct
• Option C ($3.20 million) is incorrect - this might come from calculating incentive fee on return before management fees ($10 million × 20% = $2 million, plus $1.20 million management fee = $3.20 million)

Key Concept: In hedge fund fee structures, incentive fees are typically calculated on returns net of management fees, which is an important distinction from calculating them on gross returns.