I got that error when I mounted c ~/games/dagger
when I should have mounted it as
c ~/games
Your command will probably be a little different depending on OS, but check how you're mounting the game. Don't mount c to the dagger directory, mount it to the directory that both dagger and dfcd are in.
So, say "~" is your c drive "games" is your folder in the c drive.
Put "dagger" and "dfcd" into the "games" folder
then mount c ~/games -freesize 1000
mount d ~/games/dfcd -t cdrom -label Daggerfall
c needs to be able to access files from both of those folders to run the game right, so if you mount it directly into dagger, it won't be able to read dfcd
(If you're on windows, I think the slashes go the other way "\")
Hope that helps.