It is ironic that working with younger children requires perhaps more teaching skill that working with older kids.
As far as the instrument goes, I recommend the Yamaha CGS Student Classical. It is 4/3 size, but the guitar is only the tip of the iceberg....
If you don't think children can be taught to play, I recommend you see the now famous video of the Korean Kindergarten Class http://www.youtube.com/watch?v=yE7waNi5dc0
Notice the proximity of their head to the fingerboard. In order to achieve this magnificent playing position, they have custom chairs. In lieu of having the perfect size chair, you may place a box of some kind under their feet that insure that the guitar is UP. Nothing will get accomplished if the guitar isn't positioned comfortably. I cannot stress this enough.
You must be sure that parents are involved and that there are specific homework practice assignments. Be sure to cultivate the attitude of seriousness - the guitar is not a toy but a tool to develop stamina, dexterity, and spiritual character. Both parents and kids should know this from the outset.
To begin, with I like melodies on a single string.
Melodies on multiple strings may follow.
When it is time for chords, start with rounds using one chord.
For the right hand, open string rhythms and exercises should be practiced.
I personally advocate the use of a strap tied around behind the nut.
I have a nice section of single string melodies and beginning ensembles in my "Guitar Essentials" level one. You could check out my Mel Bay Book "Blues for the Young Beginner" which uses single string riffs throughout.