I am not from Calif. but from what I can tell the choice is yours whether or not to keep the ill pup. You would still be due up to 150% of the purchase price if vet bills are that high.
Here a link to the whole thing.
http://www.dogplay.com/Breeding/lemonlaw.html
You may also want to look in your yellow pages for some kind of consumer advocate to call for help. I think I would do this first thing tomorrow.
You only have 5 days to notify them of the diagnosis though, I think.
I would copy all your bills along with the surgery estimate. I would put in writing what you expect...150% - the 488 they gave you already.
Let them know you are serious and read the law.
I wish you luck and hope your baby gets treatment and well soon.