Low Engine Knock

Not sure about your options, I imagine start calling places and getting quotes. As far as if they're wrong, if you want to make sure, just take it to another dealer and ask them the same question, see if they come up with the same diagnosis. Good luck!

I agree, take it to some other shops for more opinions. If you get the same diagnosis, it would be a great time for a rebuild with forged internals.

It won't be cheap by any means but you could do it on a budget.

My enigne all together in my 96 was around $6k.
The shortblock itself was $2500. Al Papitto of Boss 330 Racing built it using my original 96 block and crank. The block was bored .020 over and the crank was turned. He assembled it with forged CP pistons, forged manley rods, and ARP main studs.
The labor for r&r of the engine and labor for disassemble and assemble of the longblock will really depend on what shop you would go to. Just to give you an idea out of the other $3500 spent on the engine only $200 of that was labor. It was for assemble of the longblock and cleaning of the used cylinder heads and valve train. I was the one who removed the engine and installed it.

Not necessarily. Mine was $6k because I had it built to run a turbo making 700hp+. Everything in that engine is brand new, I did not use anything over. All new hardware, new oil pump, chains, guides, tensioners, oil pan, valve covers, oil cooler and adapter, etc... I also upgraded to billet oil pump gears, ARP head studs, I then went with 03 heads/cams and a 99 intake manifold. This is all stuff you will not have to spend money on.
I personally think you could have a decent shortblock built for around $2k if you could find someone locally to do it. If you can't a majority of companies charge around $3k for a forged 4.6 aluminum shortblock. Using all of your existing components a mustang shop could probably do all the work for probably around $5k. If you went with a reman engine from ford it would probably cost around $3.5k for the new longblock, but would probably run around $5k in the long run also.
I personally would not get rid of your car, low miles and a great color. Its up to you though, take a big hit selling it or put a good chunk of money into it. I went through the same thing with my cobra 3 months after I bought. The engine developed a rattle that sounded like a power stroke diesel. Although the car was not raced and stock the previous owners did not keep up on the oil changes. Instead of taking the huge hit trading it in I decided to make some good of it and start building up the car for the future mods I was going to add.

I was in your position less than a year ago. Rebuild/replace a motor or sell.
Depending on options, rebuild /replace was going to run $5,000 to $10,000,
and I could not swallow selling the car to someone knowing that there was a problem with the motor.
Long story short, I traded my '97 Cobra Convert. with bolt on's (60000 miles)and aftermarket wheels in for an 03. Got $10,000 allowance for the car. Easily 3,000 less than I could have gotten on the street, but as I said that was not an option.
Looking back I think the decision was a no brainer (financially as well). Even with the new Cobra on the horizon I am very happy every time I drive the car.
Even better for you, if you can find a 03-04 Cobra on a lot now, you will steal it, for sure.