1. I've heard of people doing it, though I don't have any specifics off hand. 99.9% sure it's possible though.
2. Definitely take iDVD '04. I use a 466Mhz G4 and though I don't use iDVD often, it's still quite operable when I am using it (have lots of RAM and leave it encoding during the night...).
3. When I upgraded I went internal but that was mostly because of iDVD not supporting external burners. There is a hack out now which allows you to burn to external drives (among other things) with iDVD '04, but I haven't been following it's progress. If I had to decide again today, I'd probably still go internal (although your eMac is a lot harder to upgrade then my PowerMac G4 is) simply because of the cheaper price, no need for the portability and guaranteed compatibility with iDVD since it's the same drive Apple uses!