Recently I came across another connection problem that was not related to data sources or application pool account privileges. We were unable to connect to the web service in Dashboard Designer but couldn't figure out why not. We checked everything. Eventually we tried to simply browse to the web service location in IE. On trying to browse the .asmx we were faced with a descriptive stack trace that gave us more more of an idea of where to look to solve the problem. BTW, it is worth noting that we were working on a standalone PC being using for development, not a server.
The solution came courtesy of Hassan Syed, an excellent .NET consultant I have been working with recently who maintains a blog named "From fragile to agile" (love the name). Without stealing too much of his thunder I will say that the problem was probably related to installing .NET 3.5 long after PPS M&A had been configured and had been working without issue. Hassan has documented what was done to bring the web service back on line here.
It should come as no surprise that a newer version of the framework could possibly cause problems with software that was written on an earlier version. Nonetheless, if you do want to upgrade to 3.5 Hassan's post is worth noting.