Yes, always best to extract the DAT file to MPG file directly from the CD with Isobuster (or VCDGear) but if its on your HD and it plays okay, then convert the same to mpg.
Play the MPG file with WMP or WinDVD to make sure its ok.
Load MPG file into VirtualDUB, set Video to Full Processing Mode and select Compression and from that window selct DivX Low Motion (for DivX 3.11) or DivX 5.x. Configure them to a bit rate of 800. Now go to Audio Tab and set to Full compression mode, select Compression and and select MP3 and 96kbps, 44.1khz , Stereo. Now go to Fle and select SAVE AS AVI. Sit back and watch the DivX being encoded.