I am trying to setup windows server 2003 domain at my friends business, all of the workstations should have the following setup as their DNS server in the network settings:

I am trying to decide the best answer..

A. The ISP’s external DNS Server ONLY
B. The ISP’s external DNS Server and the internal domain DNS server
C. The Internal DNS Server ONLY
D. The Internal Gateway and the Internal DNS server

In my opinion, the DNS should definitely be internal because it tends to be more reliable and tends to be faster. I Guess this at least eliminates options A and B.

I would recommend using the internal DNS servers as the client DNS setting. This will insure that all clients will update their A records correctly. I would just have your DNS server forward to 2-3 your ISP's DNS servers.