I have exactly the same problem as you describe. icon folder, no recognition...... mine is Seagate sata 80GB HDD (customizing figure), 1GB memory. it seems to happen so many bad situation when you go to apple dicussion forum.
anyway it was just happened last night during working on important stuff. well, I can't even recover part of important data right now because of complete dead. like you said, recovery cost is very expensive. I didn't go to apple store yet. I am busy to finish something.
interesting thing is that Apple store sells upgrade model which has 1GB memory, 80GB HDD both for white, black. it's store only. so it is possible to replace my HDD. but not sure.
it's the first HDD failure inside macintosh in my mac life for 15 years. macbook has 24 different defective symptons which I've never seen this so many problem before previous macs.