I haven't got a local host so I can't duplicate the setup you described, but I can give some clues to template switching.
Miohtama has identified, earlier in this post, the places that link templates to types of browser, this is just a description of how I see template switching in practice.
Assuming you would like the site accessible to both PC/laptop and mobile browsers.
There is one default template just like you had before you installed Mobile Joomla, and this will continue to be used by PC/laptop*. When you install Mobile Joomla, four extra templates appear in the template manager. These are not identified in any way in template manager, i.e. you do not select them here. You choose the template by parameters on the modules and MJ settings menu.
When Mobile Joomla detects a mobile browser, it chooses one of 4 types of browser (iPhone, imode, WAP, PDA) and sets a flag _MJ to say that a mobile browser is in use. During the cycle that Joomla! goes through when it's preparing to send output, it calls all of the enabled modules. If a module such as main menu (mod_mj_imode_menu) is called and MJ has determined that the browser is an imode type, then the position parameter of the module selects the template that will be used to display the output from that module.
Hope this helps you visualise how the templates are activated.
I have domain (multisite support) enabled rather than disabled as you described.
On my site, which is not a local host, I can force Firefox to show the different types of template by using
iphone.joomlasite.com or
imode.joomlasite.com or
pda.joomlasite.com or
wap.joomlasite.com instead of
www.joomlasite.com
(I had to install wmlbrowser and XHTML Mobile Profile to allow FF to display WAP)
Please describe where in Joomla! you configured menus to use Mobile Joomla but hit "Incorrect use of Mobile Joomla" error and I will try to advise.
Thanks
*Some Mac users have reported that a Safari browser is sometimes determined to be a mobile browser and displays the site as if on an iPhone instead of a laptop/mac.
Post edited to say modules rather than plugins. 17:32 BST.