Also you have the problem that the newer cases are thinner than the old. Below is a picture that compares the 2006 white iMac to the 2007 (and the 2009 models got even thinner still). I've opened up an intel 17" imac a couple of times and found the components to fit in very snugly. The optical drive has a daughter board mounted to the side that increases height, this would have to be replaced which would increase cost. The heat sink will need adapting or replacing, this would be a very difficult task and would increase the cost. The display connectors on the 17" are physically different and located in a different place, you would would need some sort of adapter/extension which would increase cost. ...Etc etc. I've only just scratched the surface and you can see where I'm going here.
The case would need modifying to mount everything - some parts such as the ram slot and rear ports will be more difficult than others and result in an eye-sore. Even if you could get everything to fit, the differences in the airflow system would almost definitely cause it to overheat.
By the time you replace the optical drive, cables, fans, heatsinks, and the cpu to a core2duo to run lion, you'd have spent more money on a slower computer that will certainly give you power supply and heat problems.
My eyebrows raised when you said a computer repair shop guy told you he'd do it. I suspect he has no idea what he's talking about. It would be a miracle if he even got as far as creating an overheating underpowered frankenmachine - let alone for only $130. I bet he'd get no further than take everything apart, feel like crying, and then fob you off with a lie about pre-existing hardware faults.
One last thing. The 17" intel imac is an excellent, smart looking machine. I bought one second hand a while ago and my Son has it now. The screen, although smaller, is clearly superior than the cheap TN panels that apple later put on the 2007/8/9 20" imac and the specifications are fine for most tasks. My Son even plays portal 2 on it (in windows7 through bootcamp) and it runs it really nicely.
My advice is upgrade it to a core2duo, keep the case as it is and you've got yourself a very nice little computer for a bargain price.