Buyer unhappy with eBay purchase! Help!?

The buyer has opened a case in the eBay resolution center and claims item was not as described and was used, not new, when he received it. The item listed was a brand new, factory sealed, TMNT PlayStation game. I know it was never opened and unscathed, but he claims when he received it the plastic at the top was open and the game easily fell out and the manual inside was worn and the disc had light scratches...

I have the highest integrity in listing items and have never had negative feedback and just would not list something as new that was used. He paid $6.40 including shipping for the item and is asking that I refund him the shipping costs and he keeps the game since he does not want to pay out of his pocket for the shipping to return the item. I am having trouble with this because I really feel like he is making all this up and I am going to lose $5 in the sale. I know that is not much, but its the principle of the matter that has me not knowing what to do! Of course he is threatening with several things, paypal claim, negative feedback,etc. and I am sure it is not worth that over $5 but I am looking for some advice from other sellers or just an easing of my mind that some people just suck!

So what should I do?

1)Suck it up, eat the $5 and refund the shipping?

2)Ask him to return the game and I will refund him the $6.40 once received?

3) Stand my ground that is was brand new, not offer a refund and take what comes (i.e negative feedback, paypal claim, ebay case resolution, etc.)?

Thank you for your help and advice!!