Sounds like a failing CRT display to me. They are all kinds of fun to change in any CRT iMac. (Being sarcastic there!) You can either try and find a new/used display somewhere and install it yourself (be careful...CRTs can shock the piss out of you even though there isn't any power going to them, unless its been discharged). You can also continue to use the external display, or you can scrap the whole iMac. If you do decide to scrap the whole iMac I would sell it on eBay and just say it needs a display, or this is a good machine for parts. I'm pretty sure it would sell. You can also take it all apart and sell the parts separately on eBay.
Just some options...