Functions within a function are better off as anonymous returns from create_function(), unless you want to be able to call it elsewhere.
However, I have used this in skinning: I use alert_box() to display certain errors, like a faulty SQL query. This simply calls display_alert(), which is defined in my skin scripts. However, alert_box() is sometimes called before I know which skin to load, so it has its own functionality which it uses if function_exists('display_alert') returns false.