The Muhling Motel’s owners have decided to have Servco, Inc., manage their hotel. The management fee arrangement would be as follows:

1. Basic fee: 5% of gross sales 2. Incentive fee: 15% of IAUOE. The payment of incentive fees is subject to the motel’s making its debt reduction payments (exclusive of interest expense) and the owners withdrawing 5% on their investment annually. Any incentive fee not paid is accumulated until paid. Assume incentive fees are paid only on December 31, the last day of each year.

Any unpaid incentive fees earn interest at 10% per annum until paid.

The interest starts as of January 1 of the following year and is paid on December 31 of that year. This interest expense is not considered a fixed expense, but rather an operating expense for purposes of calculating the incentive fee.

The expected sales of the Muhling Motel are $4,000,000 for 20X1 and are expected to increase by 10% each year. All operating expenses, including any interest on unpaid incentive fees, total 70% of total revenue.

Fixed charges equal $700,000 annually. The payments on debt, excluding interest expense, total $180,000 annually. Assume the Muhling Motel’s income tax rate is 25%. The owner’s investment totals $1,500,000. There is no depreciation expense since the Muhling Motel leases its building and equipment.

Servco, Inc. expects to incur operating expenses exclusive of income taxes equal to 150% of the basic fee. Assume that its tax rate is 28% and that all fees are taxed when earned regardless of when received. Servco’s cost of capital is 10%.

Required:

Calculate the present value of the cash flows from this management contract for Servco, Inc. for the years of 20X1-20X5.