Actual depth of the needle in water, h1 = 12.5 cm
Apparent depth of the needle in water, h2 = 9.4 cm
Refractive index of water = μ
The value of μcan be obtained as follows:

Water is replaced by a liquid of refractive index,
The actual depth of the needle remains the same, but its apparent depth changes. Let y be the new apparent depth of the needle. Hence, we can write the relation:

Hence, the new apparent depth of the needle is 7.67 cm. It is less than h2. Therefore, to focus the needle again, the microscope should be moved up.
∴ Distance by which the microscope should be moved up = 9.4 − 7.67 = 1.73 cm