The dealer is trying to make money. You have no codes at this time. The 1996 850 turbo will never go to a ready state, but you have a 1997 NA, so that should not be a problem.
There is a drive cycle to get the engine back to 'ready', which is quite extensive:
http://en.allexperts.com/q/Volvo-802/Drive-Cycle-Volvo-850.htm
A headgasket leak can only be determined by checking the antifreeze for oil and the oil for antifreeze. OR: a compression test, or looking down a spark plug hole and seeing a shiny piston.
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My name is Klaus and I am a V♂lv♂holic
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