Every business needs a domain!

In working with some really small businesses lately (3 to 4 computers) I've realized that, even at that size, having a domain is worthwhile. Synchronizing usernames and passwords on a workgroup and creating permissions can get time consuming. It really goes south when you try to implement some kind of regular password change!

The only argument against it is expense but, even if you run it on plain workstation hardware to reduce expense, it's worth it to have a domain controller on site. Running Server 2008 on a decent workstation is totally do-able in a small environment.
Having a Windows server/domain gives you management capabilities that will save the client money (and me pain) in both the short and long run, namely: Active Directory, VPN, DHCP, DNS, WSUS, Stable File and Print serving, Remote Web Workplace, and Group Policy.
In addition, if and when the client expands, the server will be ready to handle the extra connections (unlike WinXP which is limited to 10).
Just having an admin login to every workstation that is the same is worth the extra $700 or so.
When speaking to clients of this size in the future, I am definitely planning to push for a purchase of Server 2008 even if the hardware it runs on is not that great...