<p>I want to develop a mobile web application using asp.net 3.5 that can be viewed on an iPhone but there is no longer a template in VS2008 to enable mobile development. Can this be done ?</p>

the iphone uses the "regular" version of your website so developing a "mobile" version would nto accomplish what you're looking for. You should check the browser headers and redirect people to the iPhone version of your site if you detect mobile safari.
http://iphone.facebook.com/
Another option (if you're using MVC) is to have your controller detect the browser and show a different view if it catches mobile safari. This way you wouldn't need a duplicate site, just two sets of views.