A short primer - there are three MPEG-4 video specifications of note.
MPEG-4 ASP - this is what DivX is based off, DivX along with 3ivx, Nerodigital are commercial implementations of this video format. XviD is an open source implementation of it.
The containers used depends on the flavor of the codec DivX uses .avi/.divx, XviD uses .avi/.mp4, Nerodigital uses .mp4 and 3ivx uses .avi/.mp4. The Xbox 360 now supports MPEG-4 ASP in .avi & .divx containers.
MPEG-4 SP - this is a simpler version of the above standard and is what Apples MPEG4 in .mov files is based off along with some other niche or out of date codecs. The Xbox 360 actually supports MPEG-4 SP in .mp4 containers.
MPEG-4 AVC - otherwise known as H.264 video which is a wide ranging format designed to accommodate H.264 video on cell phones to broadcast quality video to HD movies. Because of the H.264 specification is so large it was compartmentalized into profiles with baseline (the most basic implementation) followed by main profile (middle of the road) and then high profile (the full works).
Nerodigital AVC, x264, Apple H.264, Mainconept, Flash 9 & more are all based off this standard though generally again Apples is the most basic and all the others are H.264 high profile. The Zune software however is H.264 main profile only & will not accept non-compatible H.264 videos into it's library but the Xbox 360 can play back up to H.264 high profile in .mp4 containers.
The official container for H.264 video is the MP4 container though it can also be shoehorned into the .AVI container but there are limitations from doing so and finally the open source container .MKV but MKV is special as it can hold any combination of video/audio.
The MP4 container supports all of the above video types along with MP3, AAC HE, AAC LC and AAC 5.1 as audio formats but not every piece of software implements those options and not every device supports those in playback. The Xbox 360 only supports AAC LC audio in MP4 no other types are supported.
Phew...
TLynnM4591 - XviD4PSP is just an encoder it will not embed cover art in .mp4 files whether they are video or audio for that you must manually use
mp3tag software and inject the jpg yourself into the file.
The Zune software should auto display & download cover/album art for any music that is in it's library ( and that goes for audio ripped to .mp4 containers too) if the .mp4 file has video in it then it will generate a thumbnail and display that in the Xbox dash. If there is cover art in the video .mp4 file then that will over-ride the thumbnail and the dash will display the cover art instead.