What version of Windows XP do you have? Pro or Home? Also, what Service Pack did Windows XP come with on your installation disk?
XP Pro SP3
Is it the same as the service pack that is on the hard drive?
As for installing Windows 7 on the hard drive, if you have an upgrade version of Windows 7, just install that. The first time, boot from the installation disk,
The Win 7 disc correct?
and select "Custom" for the type of install. When you are prompted for the Product Key, do not put that information in, just let Windows 7 install itself on the hard drive. After it completes the initial installation, run the installation CD from within Windows and, this time, choose "Upgrade".
And the Win 7 disc again?
When prompted for the Product Key this time, type it in, then let it upgrade your Windows 7 installation.