Final answer:
The increase in annual after-tax profits if the higher transfer price of $1,250 per unit is used can be calculated by comparing the costs and revenues at the current transfer price and the higher transfer price. The increase in annual after-tax profits is $670,000.
Step-by-step explanation:
The increase in annual after-tax profits if the higher transfer price of $1,250 per unit is used can be calculated by finding the difference in costs and revenues with the new transfer price compared to the current transfer price. Currently, affiliate x sells 13,400 units to affiliate y per year at a transfer price of $1,000. This means the total revenues for affiliate x is 13,400 x $1,000 = $13,400,000. The total costs can be calculated by subtracting the marginal tax rate (20%) from the transfer price: $1,000 - ($1,000 x 0.2) = $800. So, the total costs for affiliate x is 13,400 x $800 = $10,720,000. This results in an annual after-tax profit of $13,400,000 - $10,720,000 = $2,680,000.
If the higher transfer price of $1,250 per unit is used, the new total revenues would be 13,400 x $1,250 = $16,750,000. The new total costs would be 13,400 x ($1,250 - ($1,250 x 0.2)) = $13,400,000. This results in a new annual after-tax profit of $16,750,000 - $13,400,000 = $3,350,000.
The increase in annual after-tax profits if the higher transfer price of $1,250 per unit is used is $3,350,000 - $2,680,000 = $670,000.