The Daily Mail says Leicester insisted on City giving them £65m plus a player to reach their staggering valuation of £95m.
However, City were not prepared to go above £60m and walked away from the deal knowing they can resume their pursuit in the summer.
A close friend of Mahrez, who has worked with the Leicester star, said: "Riyad is very low this evening over the events of the last two days.
"He doesn't understand why Leicester have behaved in this way. This is the fourth transfer window in which Leicester have said they will allow him to leave.
"He played a huge part in Leicester's promotion in his first season. He then helped them make history by winning the Premier League title, and he has done what the chairman asked of him, which was to stay at the King Power and secure the club's Premier League safety.
"Leicester would also have made £59.8m profit on the player they bought from Le Havre for £350,000.
"He has been told by many of his former team-mates that in order to get out of Leicester you have to go to war; something he has tried to avoid and does not want to do.
"He has given his all for Leicester this season so he could leave in this window. Joining Manchester City would have been a dream for him. Playing for Pep Guardiola is something he is still desperate to do.
"That seems a long way off right now. He's very down about how he's been treated by a club he has served so well."