Yes, Hyper-V supports installing a guest OS on a dynamic VHD.
I just did it.
During the install process, I also had to setup a partition and format that partition.
I chose the maximum size of the disk as my partition size, and I formatted the disk before selecting that partition as the target for the Windows Server 2008 installation.
I checked the available disk space on the physical drive during install, and it appears that the full size is not allocated immediately, but the expanding works as expected.
For example, my maximum size if 40Gb, and the size during install was down around 10Gb, and increasing as the install copied more files.
My goal is to have the smallest possible system drive for my VM, and yet, always have it expand as necessary if I have to install some programs there.'