Make your driver backups first. Copy them out of your computer to a Cd or flash drive.
#1: Yes. Setup will offer to format the drive you are going to install Windows on. It will also give you a choice of file system you want to use. Choose NTFS. If the drive is already NTFS (it will indicate current type), then you can do a "Quick Format."
Choose the 150GB drive to be the primary (first) hard drive in your system BIOS! Your BIOS may have a selection for hard drive boot priority, make that choice here. Your BIOS will also have a Boot Priority setting, which is different. Here you determine what storage device is actually going to boot the machine, CD ROM, Hard Drive (the one previously selected), Floppie drive etc.. Make the CD ROM the #1 boot device and the Hard Drive the #2 boot device.
The hard drive boot priority is VERY important! If you boot to the wrong drive, it will be catastrophic to format the other drive later as it will be the drive with the Windows boot loader on it.
The problem: Windows Setup isn't all that smart. You can have the larger drive be the physical boot drive, but have windows installed on the 150GB drive. It will actually work. Only a small loader will be added to the larger drive to send the computer over to the 150GB drive to finish loading Windows when the computer is turned on. It will work, but, here is trouble waiting to happen in this situation. You decide to format your larger drive one day.. fine, it formats. Next time you start Windows, it can't! Because the boot loader is gone, the format erased it! Bummer. So select the 150GB drive in the BIOS as the preferred #1 drive for a hard disk boot. I've gone on and on a bit about this because it is a sad trap to fall into.
After Windows is installed, Windows can format the other (large) drive.
#2: The larger drive does not need multiple partitions, if it is going to house video files, MP3's, DVD copies, downloaded program install files etc. It is going to be a giant storeroom of your data collection.
#3: Installing Windows and your programs on a 150GB drive is a good choice. It's quite large enough for a lot of programs and games.
#4: Nearly all hardware components need a driver. Most drivers are automatically installed by the Windows Setup program. Windows Setup cannot possibly hold every driver for every piece of hardware made out there. Video cards, sound cards, specialty cards all need drivers, and many of these cards were designed and built after Windows XP was published. Service Packs have hundreds of additional drivers, but still cannot ever hope to cover all possible devices. Device manufactures supply drivers to their hardware. These drivers are ones probably not built-into Windows.
The program I supplied a link to will back up every single hardware driver in the machine, even those drivers Windows had it's own driver for. One reason to make all three versions of the driver backup is to give you versatility when installing drivers.
If you make the "Zip File" backup, and expand it into a folder in this machine you are now using, or, on another machine that has a CD burner. You can make a driver CD for your computer. After Windows is installed, you can put that driver CD in your machine and go to the Control Panel, under "System" and Device manager to load drivers. You would right-click on each driver that has a yellow exclamation mark in front of it and select "Update driver." Windows will offer to go look up the driver on the internet, but you decline and specify you want it to look at a CD for the driver. Windows will scan the entire CD looking for the proper driver and when found, will install it from there. It doesn't get much easier than this.
If you make the "Self-Installing" version of the driver backup, after Windows is installed, you would launch the backup EXE file and it will take about 10 minutes, loading every single driver in where it belongs with no more intervention from you. Now it does not get any easier than this!
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