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1. It really depends on your site. I usually send it to the home page if it's a local site with 5-20 pages.

2. If the links are in the same category, the only downfall would be that pagerank is split up to your two different pages. It's good for users and crawlers though.

3. Stick to high quality directories (dir.yahoo.com, botw.org, business.com), you'll spend more, but it will be worth it. Combine them with some niche directories and natural link building and you should be ranking with little problem on a moderately competitive keyword.

You are right in that you would be better off having your blog in sub-directory rather than in a sub-domain.

Sub-domains are very close to being considered the equivalent of a new root domain. For example, Wordpress.com and Blogspot.com blogs come automatically registered with a new subdomain. There are hundreds of thousands of these blogs, but only a few actually have any authority despite the authority of their root domain.

When you create content on your blog in a sub-directory, your inbound links to those posts will help the authority of the domain you are on. So links to www.example.com/blog will help you out much more than blog.example.com.