I went through Michael Washington's DotnetNuke 4.0 Module Developmenet Document, which is very good except for one apparent contradiction.  In the "Setting Up Your Development Environament," it reads that developers should use the "Install Version" of DNN to do their development.  However, in the section on "Using Web Application Projects (WAP)," it instructs the developer to use the "source version" of DNN to do their development.  Is it OK to use the "source version" of DNN and the technique described in this section to develop modules? 

You refer to : http://dotnetnuke.adefwebserver.com/DotNetNuke/tabid/195/Default.aspx

I tried with the source, but it did not want to compile. Remove the web.config and rename development.config to web.config did the trick. I added a project (C# template downloaded instead of the VB template which is shipped with starter-kit - for that reason you probably need to install it), but I was wondering if the add to project to the desktopmodules is the correct way? If you publish the project the dll's are not there? Must the desktopmodules for sure be in the project of DNN?

I am also wondering how to use the C# template.

Always use the install version, here are a few reasons why:

If you have other modules installed, those modules may references a different DotNetNuke version.  If you select the source version the DNN dll gets a new version and unless you spend a bunch of time making sure that everything has a project reference to that build output - you're in for a headache.

The source version takes a lot longer to build, longer to load, and longer to do everything else.

Editing the DNN source code is NEVER a good solution to a problem, there is almost ALWAYS a way to avoid editing the DNN source by using Desktop Modules, HTTP Modules, or HTTP Handlers.

All this being said, I always work in an install version - however I do have a source version project that I use for read-only purposes.