I would put in markers every 10sts so the when you fold the hem at the purl row, you don't miss a stitch and skew the hem. If you put the sts from the invisible cast on onto a third needle in groups of 10 or so sts, that should also help keep you on track.
Yes, you knit through the loop from the cast on with the loop from the last row knit. Sounds like both of these are in the brown color rather than the auxilliary color.
For the increases (and it seems particularly mischievious to make you do this at the same time as the hem) a make one may be easiest. Depending on the next directions, you might consider putting the increases on the next row. You don't have to get the increases precisely even, every 9 or 10 sts will work out. Again, using markers will help keep you on track with the increases as well. You might also try the M1 or the kfb on a small swatch and see which you think goeas best with the folded hem.
It's a very good-looking pattern. We'd love to see the finished vest if you'd care to post a photo.