To refund a PayPal payment:

• Log onto PayPal
• Click the History subtab.
• Find the payment you would like to refund and click Details.
• Click the Issue Refund link (at the very bottom of the page).
• Enter the refund amount and click Continue.You can issue a partial refund here. It's a good idea to put a note to the customer about what you're refunding.
• Confirm the details and click Process Refund.

You should note when looking at the orders that you can print a shipping label from PayPal, which simplifies things and is a nice way to track the process!