Handling of pathnames in projects?

Folks,

I'm finding the handling of pathnames in an MDK 5.1 project very confusing, and neither the online docs nor previous messages in this forum have been useful.

Consider the following situation -- I have a project with the following folder structure:

PF                                         <project folder>
    main.c
    subroutine.c
    subroutine.h
    ...<some other source files>
    ARM                                    <folder created by MDK>
        MyProject.UVProj                   <UVision project file>
        ...<other stuff>
    GNU                                     <folder created by MDK>
        ...<stuff>

This is also represented in a Group/File structure inside the MDK Project Navigator Pane as follows:

MyProject
    app
        main.c
        subroutine.c
        subroutine.h
        <some other source files...>
    core
        <some ARM startup code>
    Include
        utility.h

Note that all file references in the Project Navigator are correct in the sense that the little icon next to each one is filled in (not blank) and double clicking on it will open an editor pane with the file's text. File utility.h is not in the project folder, but external to it (up a couple levels and then down another branch).

Files subroutine.c and .h were also external to the project folder and I had trouble with the compiler finding them. Got 'error: #5: cannot open source input file "app_util.h": No such file or directory' error messages. Doesn't matter whether I include a complete, full absolute pathname for the file in its Options > Properties > Path: setting or a relative path (both of which work for opening the file for editing in MDK). What gives?

So here are some specific questions:
1. Why does the compiler fail to find files when the files' pathnames in the files' properties is correct?
2. Is there an "inheritance" mechanism for file pathnames of files added to the project that runs from the Project properties to the Group properties to the file properties? If so, how does it work?
3. Same question for Include paths (although here I suspect it's "multiple inheritance", i.e., include paths accumulate, rather than get replaced in traversal down the chain.
4. What are the guidelines for using absolute vs. relative pathnames. (In one response on this list, it was suggested that relative paths should be used for files in the project folder, absolute paths otherwise.)
5. Most importantly, what's the root of relative paths? For an include file, is it the location of the file referencing it? Or the first level inside the project folder? The location of the .UVPROJ file? Or what?
6. For includes, is the search only one level deep or recursive?
7. For error #5, when the compiler fails to find a file, why doesn't it at least indicate where it expected to find it? That would be a lot more useful :-)
8. Are there answers to these questions in the manuals, the online docs or this forum for these questions which I've missed? And how would I have found them? (For example, searching for "pathnames" in the online help only revealed a couple references to obsolete assembler info. A search in this forum only produced a user's query about why they were geting Error #5, followed by a snarky response complaining that the user asked an insufficiently detailed question. Hopefully, this one is detailed enough :-)

Sheesh.... this issue shouldn't be this difficult. Comments?

Mike