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There are several questions that I have based on your description. First what service pack are you using with 10? I would recommend upgrading to 4 or 5. Also you mentioned that you receive a warning, which coordinate system are you rectifying to? To make it simple, I would put the data frame into the coordinate system that you are looking to make the rectified image in. If you are mix and matching the coordinate systems then I would consider what coordinate system the output it is.
Per the help documentation, "Rectifying or warping will create a new raster dataset that is georeferenced using the map coordinates and the spatial reference."
So make the data frame the coordinate system that you would like have the new raster in. So check the properties of your current rectified raster to see if they match the data frame. If you really want to use the other raster, I would also consider projecting the DEM being used.