Explanation

Let's calculate step by step:

Given:

• Beginning AUM = $100 million
• Gross performance = 30%
• Management fee = 2% of end-of-year AUM
• Incentive fee = 20% of net profits (net of management fees)

Step 1: Calculate gross ending AUM Gross ending AUM = Beginning AUM × (1 + gross return) = $100 million × (1 + 0.30) = $100 million × 1.30 = $130 million

Step 2: Calculate management fee Management fee = 2% of end-of-year AUM = 0.02 × $130 million = $2.6 million

Step 3: Calculate net profits after management fee Net profits = Gross profits - Management fee Gross profits = $130 million - $100 million = $30 million Net profits = $30 million - $2.6 million = $27.4 million

Step 4: Calculate incentive fee Incentive fee = 20% of net profits = 0.20 × $27.4 million = $5.48 million

Step 5: Calculate total fees Total fees = Management fee + Incentive fee = $2.6 million + $5.48 million = $8.08 million

Verification:

• Option A ($6.00 million) would be incorrect as it's too low
• Option B ($8.08 million) matches our calculation
• Option C ($8.60 million) would be if incentive fee was calculated on gross profits before management fees (20% of $30 million = $6 million, plus $2.6 million = $8.6 million)

Key Concept: When incentive fees are calculated "net of management fees," the management fee is deducted first from the gross profits, and then the incentive fee is calculated on the remaining net profits. This is a common fee structure in hedge funds to align manager interests with investors.