My solution would be to just go to ATI's Website. Download the drivers off their site (screw using the Device Manager unless you know how to choose "ADVANCED" and set your own location for the install and ignore any microsoft warnings about the files not passing their inspection..
Solution One:
The easiest solution is forget your install cd go to the website, install the drivers (ATI usually uses the standard windows installer) then reboot and have it work..
Your CD is probably older than what is up on ATI's site anyway..
What windows is getting confused about is the path to the drivers.. You have to choose advanced and that you know the location of the drivers. What the select path thing then does is go out and look for a .INF file that is in the same folder tree as the actually driver and uses that .INF file to install the driver (ala magic)..
What you are probably doing when you "update driver" is pointing it to look at the CD but not to the folder where the .INF file is to the machine where to find the driver and go from there..
Solution Two:
A simple solution to your cd problem is click "update driver" clicked advanced so you can browse for a folder, then browse to wherever those .INF files are and hit okay and next for them to load..
if you browse the ati CD or did a "search" of the CD looking for *.INF I bet you'd find the folder path to where you need to point the device manager "update driver" button needs to look to install everything just fine and dandy..
Next: go to support.microsoft.com and look up ".INF" files, it will explain what these magic buggers do for you to eliminate the confusion...
