use a slipstreamed XP disk with SP2 on...
A what?
An XP CD that has Service Pack 2 'slipstreamed' over the top. Using such as disk means all files on it are at SP2 versions, and also building a PC from that CD already has SP2 on it...
Yes... instead of installing Windows XP, then installing SP2 which will replace many of the original files, you use a CD that already has the SP2 files on it. This is faster, and also takes less space since the later installation of SP2 will create a backup of the replaced files and a restore point.
'slipstreaming' is the process of taking an original installation CD and creating a new one while already replacing the updated files on it so that the software is installed with all the patches and service packs etc.
Microsoft actually provides details on it's website how to 'slipstream' the installation CDs.
As for your problem, yes it does look as if the hard disk drive is on its last leg, but just to make sure I suggest that you try unplugging it and then see if you can access the BIOS setup.