Hi, Mon-

>1) Is SQL server the natural choice for a database application written in .NET, or are there other options (I mean simpler options not more expensive like Oracle)?

The others have covered this one fine.

>2) Once we have a .NET application created, how hard would it be for our clients to install and run this application? If setup is going to be too complicated for end users, we'd then need to host the app ourselves, which leads to the next question:

Setup of a .NET application is as simple as installing the .NET framework on the server, copying the .NET application, and setting up a virtual web folder on the server. But...but there's really in truth more to understand about it, not least of which is security.

I'm currently working my way through the following document that you mind find interesting.
http://www.asp.net/whitepaper/aspnet_hosting_public.doc

>3) Are there hosting companies that would host .NET applications? These need to also host the database engine (e.g. SQL server)

I know there are more, but www.webhost4life.com is one such host.