CR 125 Melted piston and clutch prob.

I just bought a 1986 CR 125R that needs some love.  After riding it for a couple of hours, compression was bad, so I took the head off to find the piston partially melted, and the cylinder scored pretty badly.  I was told it had been bored out previously, but I don't know for sure.
When I drained the oil, it was all milky, indicating water or coolant in it.  I know this could just be seals, or something more serious.
I also have a problem with the clutch.  When I put it in gear, I have to rev it up just to keep it from dying.  The clutch doesn't fully disengage, even though the internal lever is going to it's stop.

My question is: do you guys think I would be better off finding a decent used engine, or would this one be worth rebuilding?  I can do the work, I'm just wondering which option might be cheaper.  
Also-- does anyone know where I might find an engine at a reasonable price, and what might that price be?
Thanks--  

thats a toss up
if the bottom end is in good shape i would go the rebuild route..

also do you think that the cyl is able to be repaired  
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1998 cr125
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I'll have to clean the melted aluminum off the cylinder, (can do this with a very strong acid) and see how badly it's grooved, and we'll see.  What I was concerned with was finding a piston to fit the cylinder if it's already been bored.  
I was also getting water in my tranny oil -- don't know from what, tho -- and there is the expense of the clutch, too.
I'm kindof thinking that if I can find a decent engine, I can use that, and have parts from my old one as a back up, or even sell the parts, off-setting some of the cost.  What would be a fair price for a used engine?  

you can send the cylinder out to be worked on, they will fit it to a piston available.

if the bottom is fine i'd say yeah, rebuild it, is your connecting rod and crank in decent shape?

i assume you know quite a bit about bikes, just by your post, so i am assuming your clutch cable is adjusted correctly? if it is then the clutch basket might be worn, grooved so the clutches won't disengage, what oil are you running in it?  
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I have yet to take the bottom half apart to see the condition of the crank, but the connecting rod looks to be decent-- it has some play side to side, but very little vertically.  I would imagine that I have some seals in the bottom half that need replacement- and the more I read, the more I'm beginning to think that the clutch may need to have a new kit, also.  Is the basket part of the normal kit?  
I'm using Pro Honda GN-4 10W-40 SJ oil in it, per the maintenance manual.
I'm also using a pre-mix oil ratio of 20:1 -- seems excessive to me, but that's what the book calls for.  Is that the norm for these bikes?

My knowledge comes from being an aircraft mechanic.  2-strokes are relatively new to me, as is moto, but it's certainly a good time!