Definitely use the router for connecting the two computers. As for sharing the dial-up connection, that's a little more difficult. The Internet Connection Sharing (ICS) in WinXP should allow this, but I've never worked hard enough at it to make it work. A better choice (or at least an easier one) would be something like Sygate Proxy, which does allow for the secondary computer to cause the primary to dial the ISP if the connection isn't already established (ICS may do this as well, but I can't say for sure).

Your friend will want to let Sygate act as DHCP server, and turn off that function in the router (you can't have two DHCP servers on the same local network).