This is not meant to be a complete answer, but might help with your understanding of it. My understanding of the physics of windows is as follows -
Nearly all radiation (visible, UV, infrared, every other type too) that travels from outside the house into the house and is absorbed (not reflected back out again) is converted into heat. I would expect that exceptions (such as the energy from UV light causing a chemical change, such as when it fades your couch, or waves that induce a current in a conductor) are relatively negligible.
This means any radiation that can be reflected from the window to prevent it entering the house reduces the heat load. Also, if the radiation is absorbed into the window glass (eg through tinting it), then some of the heat from the window glass will be lost to the outside (through both conductance/convection and some radiated heat) which is an additional benefit.
A heated window pane would like lose more heat to the outside than the inside because the wind would help keep the temperature difference between the glass and the adjacent outside air larger than the temperature difference between the glass and the inside air.
To answer the way the issue should be fixed is to replace the window. That way the rotted framing can be repaired too without the window in the way or have any fear of having the window drop from trying to undermine the old framing or, if the framing is still intact, if offers access to inspect it properly.
I can see though, it will be quite costly to do.
To repair the sill will be tedious, time consuming, and after all that, still may need to replace the window after all.
You will need to start by removing completely a small portion (12-16") of the window sill to see if the shims that support the window are under the window jamb behind the sill or if the window is supported by shims under the sill itself. It would be a huge help if you removed the trim from the inside too, and if needed, cut the drywall to exposed the full rough opening to the top of the rough sill. This will be helpful on evaluating all the sill from the interior to the exterior.
If the shims are under the jamb and not the sill, (this is how it should have been set) then the fix may be simpler, and you can move on with removing the remainder of the sill. Please be vigilant on the removal process that it is complete, not a hiding splinter of wood is tucked away somewhere especially in the groove that the old sill tied into, and especially that the new sill will go there too. The screws, nails and any caulk that the old sill had holding it in place goes too. Do be certain that the window is shimmed a few spots in the middle and especially at the ends where the jambs meet in the corner.
Sometime along this process you will have a chance to inspect what you can see of the rough sill that the window sets on. If the sill is decayed, the window should really be pulled and repair the rough sill. My fear is the sill is shot since the window has been repaired before and from the looks of it now the soft decayed wood will let rainwater pass through to wet the framing below it and start rot there.. To have this intact is important in the replacement process.
A sketch will be good for me to issue on the reassembly. If you think you still want to tackle the repair I will try to figure out how to get a drawing to show up here. I am new here and I have yet to figure out how to do some things. The sketch will take time too, I am familiar with Sketch Up, which I have seen used in the forums before.
Just to let you know, this is just getting to the tedious part, what I mention so far is easy in comparison, but this is the type of stuff I enjoyed doing at work when I had the chance.
I added a edited pic that you posted earlier to show how the various parts will fit in their final position. The labeling on the pic should be self explanatory for the most part.
Some details that would not fit on the pic,
the recut of the rib on the new sill needs to make the rib narrower by 1/8 inch, to keep it the same size will make it nearly impossible to get it to engage to matching groove in the jamb. I tried to set a sill to a window on the jobsite before the window was set, I could not get it to go in without a recut. Any slight bow in the sill would drive anybody crazy to get it to set. The rib is important to act as a water stop, so it really so stay intact, just a little narrower
Before all this is set in place and while this cutting is being done, make sure you get enough sill to use as test pieces, say 4 ft. extra, to make a number of 1 ft. test pieces. If it doesn't work mock up another.
Once all is going together properly, set the screws too, but do not caulk it yet, you must get it to fit first completely before you add caulk. When caulk is added between the sill and jamb to bed the sill, that will change everything enough to make it tough to reset the screws. I don't know why, it just does. I have done this stuff before and it is easy without the caulk, but as soon as caulk is added it gets really tough.
To get the angle of the screws to come out of the sill in the exact spot you need, start the drilling from the side the screw will come OUT of. This spot is in front of the rib and just passing by the inside corner of the sill out of the bottom of the sill. Where it comes out is not that important as long as it is outside of the stucco face. The most important thing is the sill is tight to the jamb with caulk in place and the screws have the least angle possible to draw the sill even tighter.
Best Answer
The major difference between a new construction and retrofit window is the way the new window frame is attached to the house.
To install a new construction window the installer will have to chip away the original stucco, cut away some interior drywall, remove the window, remove the paper backing behind the stucco, and then once the new window is in ensure the window is properly flashed and re-wrapped properly to ensure everything is watertight. After that, they will patch the stucco which was removed to perform the window install.
In a retrofit install, the windows include a Z-bar or Flush fin which which allows the installer to cut down and reuse the existing window frame to mount the retrofit window frame to. The flush fin (Z-bar) covers the gap between the inside of the existing frame and the exterior of the replacement window and allows you to simply install the window from outside rather than tearing out the exterior stucco and interior drywall.
If your original windows were installed correctly and aren't leaking the retrofit windows would be the way to go in my opinion. You will lose a tiny bit of window viewing area using the retrofits, but the install time will be much faster (and of course much less expensive) and there's no worry about tearing up the inside and outside of your house. I've never seen patched stucco that looks totally right either. The energy savings will be there regardless of the installation method you choose.