For the specific topic of turning a console executable into a library by modifying the C source code, it depends on how the command-line application is factored. If it's written in such a way that I/O is funneled through a small set of functions or even better function pointers, then obviously it will be trivial.
If it's all done with printf, scanf and friends, then you'll probably be best off by finding / creating an include file that all the source files include and adding a macro that redirects printf/scanf and friends to your own functions that are written so as to be amenable to DLL implementation. Things like printf can be built from vsnprintf (use the n-version for safety), so you don't need to reimplement the whole C RTL I/O subsystem. However, there is no vsscanf, but there are third-party implementations on the web.
If the code is using fprintf, fscanf, etc. to enable indirection between files and the console, you're still out of luck. The FILE structure is opaque, and unlike Pascal text files, a portable text file driver cannot be implemented. It might still be possible if you spelunk in your specific C RTL, but you'd be better advised going down the macro route and reimplementing your own renamed FILE type.
Finally, the "popen()" approach is possible in Delphi and made somewhat easier in Delphi 2009 with the TTextReader and TTextWriter classes. Combine these with TFileStream wrapped around pipes, and specify pipes for standard input, standard output and standard error in the new process and STARTF_USESTDHANDLES, etc., and it will work. If you don't feel like writing your own, there are third-party equivalents / samples on the web for Delphi too. Here's one.