First of all, CS4 does not work well with non-production codecs like MP4. Use the Adobe Media Encoder (or something similar) to convert your footage to a production codec (Cineform, DNxHD, Quicktime with the Photo JPEG codec or Quicktime with the PNG codec).
Second, you're running AE on a system with only 2 GB of RAM? Good heavens, man - no wonder it ran out of memory! Upgrade that to 4 if at all possible. (Upgrade to much more than that if you have a 64-bit OS and plan to upgrade AE ever. Although, on a machine as old and slow as that, you might be better off getting a new machine if you want to do anything serious in AE.)
Third, what's your exact version number of AE? You should be on 9.0.2 if I recall correctly.
Fourth, your video shouldn't be looking weird in AE. It's probably misinterpreting the pixel aspect ratio of your footage. Fix the interpretation and you shouldn't have to have a separate comp for changing its size.
You will have to provide exact render settings. From your screenshot we kinda know that you are encoding to WMV, but not the exact settings. that said, perhaps this one may be of interest:
And I wouldn't put too much stock in Szalam's words. Back in the day we still got our work done on such systems. People simply have forgotten and are spoiled these days. It's beside the point, anyway. This is not the system actualyyl running out of memory, this is realyl some internal settings/ CoDec issue.
Mylenium, back in the day, we were running on older operating systems which didn't require as much RAM too.
But my first AE machine had 1GB of RAM, so yes, older AE didn't need as much memory as current versions.
I still maintain my first point about the interframe compression scheme being a potential culprit.