That particular screen is telling you to turn on the iMac's Magic Mouse. Since you aren't using one, I am not sure why it is being displayed.
Do you, by chance, have access to the Apple Diagnostics Disk for your system? If so, running it may help islate the problem.
Will the system boot to the OS X install you have on the HDD now if you let it run?
Have you tried a different mouse or a different USB port?
Thank you very much for your reply. I fixed problem by using other OSX installation disk I had. What was wrong with first one I do not know. Actually I have another question what is this Apple Diagnostics Disk. Where can I get some info on it and if possibly purchase it. Thank you !