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Start by "baselining" your car. Replace the cap, rotor, plugs and wires. Adjust the valves. Install fresh air and fuel filters. In other words, make sure that the car runs as well as possible in stock form before you start to think about modifications.
Modifications:
Have the head and manifolds ported and polished. Delete the front muffler and install a 2.5" cat-back exhaust. These modifications will yield perhaps 10 horsepower over stock. I wouldn't recommend shaving the head or messing with gaskets because the stock motor has an already high CR of 9.8:1. If you increase the ratio, you will have to run a higher octane gas in order to avoid early detonation ('pinging'), and you will also increase combustion chamber temperatures. Additionally, shaving/decking the head will reduce the clearances between pistons and valves.
You can try an aftermarket cam (e.g. "Isky") or one of the Volvo performance cams - search the archives for more info - but I have a feeling that your stock "M" cam is the best match for an automatic transmission unless the engine has been heavily modified.
Speaking of transmissions, the single most cost-effective way to increase rear wheel hosepower is to swap out your AW-70 for an M46 (auto to manual). This is a fairly involved process, but it can be done for a few hundred dollars if you are a DIY'er with a garage. I can't prove it, but I am willing to bet that the difference in rwhp (rear wheel hp) with this swap is easily on the order of 10%.
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