Arctic Silver 5 is good stuff, but really get what you can afford. Most generic brands will work jsut as good.
Get that on there after you clean off your heatsink and make sure to spread a relatively thin amount. flatten it out with a credit card or somethign to get an even thin coat on the heatsink (only need to apply to middle of heatsink, not the entire base).
Seat it back on and you should see a drop in temps, cuz 86C is close to frying point and could have possibly already damaged something. if you don't see a drop in temps after 10 minutes or so then either you reseated it wrong or there is a probolem with your hardware.
At that point i would check in BIOS to see what your CPU voltage is at. An AMD XP2700 stock voltage is 1.65v. Als omake sure your room/case temperature isn't like 50C or something ridiculously hot. You really need a cool case/room to have cool CPU temps.
It could very well be a faulty sensor. Alot of people get reports of like 125C adn its really only 40C. Get the back of your DRY hand clsoe to the heatsink fins and see if you cna detect alot of heat or any heat. if no heat then gently touch your heatsink and see if its hot or if its warm/cool. don't touch it long..if its really 86C you could burn yourself. if it seems warm/cool its probably only 40C or so and you have a bad sensor/seated the heatsink wrong.
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Compaq Presario V5000 laptop