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Assuming the 7-1/4" vertical spacing can be accomplished (it's going to be VERY close!), I would use that spacing. It will mount the engine at Whaler's specified height, and should work well with any propeller. This also gives you the option of going up one more hole if needed.

With only 40 HP on that hull, your top end speed is only going to be around 28 MPH. This is not the realm of elevated engine heights are performance props, nor is tiller steering.

With engine only one hole up, and at these speeds, you can use a Mercury's surprisingly good aluminum prop with good results. If you go up one more hole, you may need a more expensive SS prop to avoid ventilation/slippage.

Later and current Mercury 40-60HP engines now have the 5 hole mounting pattern restored.