I've had a think, and I'm fairly certain that you'll need to change the BIOS on your chip to make the whole thing work.
A standard BIOS looks for D:\default.xbe as its first dash, and that's the file on the VGA boot disc that runs to load the VGA BIOS. However, once the VGA BIOS loads the first thing it does by default would the same thing - look for D:\default.xbe - and get into a permanent loop of loading the VGA BIOS, running D:\default.xbe, loading the VGA BIOS, and so on. Now, for the X2.5035 BIOS you can prevent that loop by changing the name of the first dash the BIOS looks for - that's what setting dvdBootXbeName = nothing.xbe in x2config.ini achieves. HOWEVER, that means that your original X2.5035 BIOS (on the chip) will now never boot from the DVD because it uses the same x2config.ini, so your Xbox won't boot the VGA boot disc in the first place - catch 22!
The solution is to put a different BIOS on your chip - iND-BIOS.5003 is an excellent alternative, and can be configured from a file in the same way as X2.5035 - but it uses a different file, so there's no conflict. That way, iND-BIOS can be set up to boot normally (including booting default.xbe from the DVD), and the X2.5035 VGA BIOS on Frosty/Xman's disc can still be set to NOT boot from the DVD, so it never gets into a loop.
Config.xml on C is presumably for your dashboard, and it's fine - it's spare copies of x2config.ini that will cause problems.