Are you the original owner? If so, you may want to investigate your situation further to see if the factory is willing to help out. I believe MB issued a bulletin that addressed certain models and their recommended service intervals of that ERA. Doesn’t hurt to try!

Following that I believe your personal expectations and your long term interest with the vehicle will dictate the direction that fits you. You might need to ask yourself "How much am I willing to invest in this vehicle?" I would think that if your answer is “Not that much” or “I am not certain” than a recycled engine may be a better choice. Stockton Auto recyclers would be a good choice for obtaining a higher quality used engine.

Aside from that have you checked with the dealers to get an idea what a replacement engine would cost? Considering the factory warranty, it may be the best option if your planning on driving this car for 5 or more years.

One other thought, has a leak down test been performed on this cylinder to confirm that it is a ring problem? I have seen a number of broken/weak valve springs (5 to date) on M112/M113 causing performance problems. Perhaps another oppinion and or some more tests on that cylinder are needed to give you a better idea of what is going on with that cylinder.

Gotta love CA emissions program