Explanation
Box 1 : VM1 and VM2 only
When recovering files, you can't restore files to a previous or future operating system version.You can restore files from a VM to the same server operating system, or to the compatible client operating system. Therefore -
"VM1 and VM2 only" is the best answer since both run on Windows Server 2016.
"A new Azure virtual machine only" ,this will also work but why to create unnecessary new VM in Azure if existing VM will do the task. So this option is incorrect.
Box 2 : VM1 or A new Azure virtual machine only
When restoring a VM, you can't use the replace existing VM option for encrypted VMs. This option is only supported for unencrypted managed disks. And also You can restore files from a VM to the same server operating system, or to the compatible client operating system only. Hence "VM1 or A new Azure virtual machine only" is correct answer.
A screenshot of a computer Description automatically generated

References:
https://docs.microsoft.com/en-us/azure/backup/backup-azure-arm-restore-vms
https://docs.microsoft.com/en-us/azure/backup/backup-azure-restore-files-from-vm#system-requirements