2) Insert the muxed VOBs directly. Vegas will recognize both the video and audio. To my knowledge, you can't insert the elemental streams. I, personally, like to use DVDShrink, as I can set a beginning and endpoint. You don't want to insert the entire VOB into Vegas, nor do you want to do edits on the MPEG, as native MPEG editing is slow. Cut out the scene you want, render out to AVI, and then edit that video instead.
2) Insert the muxed VOBs directly. Vegas will recognize both the video and audio. To my knowledge, you can't insert the elemental streams. I, personally, like to use DVDShrink, as I can set a beginning and endpoint. You don't want to insert the entire VOB into Vegas, nor do you want to do edits on the MPEG, as native MPEG editing is slow. Cut out the scene you want, render out to AVI, and then edit that video instead.