you are on the right path about installing XP, Microsoft provide detail instruction about installing Windows XP:
http://support.microsoft.com/default...;en-us;Q316941
A 1)- after installing try to activate you account from Internet after three tries it will say that you need to call in in case you have trouble (so there is phone number and their service is fast)
A 2) NTFS is always a good option if you are going to use the built in security for Windows XP.
A 3) Personally I did not have luck with WD, may be other people will disagree with me but you can get what ever you want for the right price. Don't worry about boot disk, you can install the Windows XP right from CD, just have to change the boot sequence to boot to CD first in the BIOS.
A 4)
http://www.winhex.net/
http://www.file-recovery.net/
I have used File-Recovery before and it work some-what for me,, if you want a total recovery then it will cost you arm and a leg (plus the first born). I would just plug in the bad drive to the system see what happens, maybe the new OS will pick it up.
cheers