Stop, Stop. You guys are killing me here.
Start over.
In the TE (remember which terrain is up)
Select the default tab, 'Terrain', the screen with grass etc
Click the 'Save Textures' button
Open your terrain folder
Look for the new 'savedtex' folder inside
Inside that, find terr0001.bmp
Notice it's 512x512, 256 color
Open MS Paint, whatever
Create a 512x512, 256 color tile
Make it all yellow and with the text tool, write "terr0001" in the middle of the tile.
Save it to your texsrc folder as 'terr0001.bmp', in your terrain folder of course
Clear your cache folder and launch the TE
Set a grass tile and report back what you see.
While you're at it, click the Manual button and change one of the radio buttons and then report what happened.
I had you save the textures so you will have the rest of the pieces you'll need.
Still lots I don't know, and most things require ac3d.
Edit: You only need remove the appropriate terrain files/folder from the cache folder.
