I'd stay in the City. Napa is nice, but if I had to choose, I'd stay in San Francisco, especially if you've never been or haven't been much.
The last 10 times or so I've stayed there I've gotten hotels through Priceline.com, which has worked out very well. I usually bid on four-star hotels in the Union Square area and get either a Marriott, Hilton or Hyatt. It looks like they're going for between $80 and $120 or so on Priceline during late August, though that depends on the day of the week. These hotels are pretty standard business-traveler-quality options. If you have something special in mind, you'll be better off avoiding Priceline.
My sister stayed at the Parc 55 recently and really liked it.
One thing to note is that if you will have a car with you, you're going to pay around $50 a night for parking at any of the hotels. You can usually find parking in lots downtown for less, but it's a hassle parking there and walking to your hotel. And driving in SF is no picnic, so there's that, too. May be better to skip the car if possible.
As far as must-dos, it's kind of hard to go wrong. A lot of people will tell you to avoid Pier 39/Fisherman's Wharf, but they can both be fun in their own (very touristy) way. I wouldn't make a day of either of them, though.
Other classics are Lombard Street, North Beach, Chinatown, Golden Gate Park, the Haight, cable cars and Alcatraz.
The SF Chronicle web site (sfgate.com) has some good resources that are worth checking out. They annually rate their Top 100 restaurants in the Bay Area (sfgate.com/food/top100/2007/). They also do a "bargain bites" list with lower-priced options. There are lots of good recommendations in there, though just about anywhere you go is going to be pretty good.
La Taqueria in the Mission gets raves for its burritos and tacos. Delfina is popular for Italian food, though there are tons of Italian places in North Beach. A favorite of mine is Chow -- one is on the periphery of the Castro, another is near Golden Gate Park. They're both very good, but not the place for a romantic dinner.
SFgate also has a good guide for visitors (sfgate.com/traveler/guide/) that I'd check out. Lots of good stuff.