Ok, here we go, you can rest assured that you can and in fact have the right idea on what to do, the problem is how to do it.
If you itend to perform a CLEAN installation of Windows Xp Home then this is my suggestion step by step.
Step 1, Using either your 40GB 0r 120GB hard drive, Fdisk the drive, create a primary partition of not more than 10GB, then on this drive create a secondary partition of the remaining 30GB of course make sure the first partition is set ACTIVE.
Step 2, Fdisk you second hard drive, if the second hard drive is used to save your work then just Fdisk as a single partition, otherwise Fdisk and partition this second hard drive with many partitions a s you require.
Step 3, Install Windows XP Home in the primary partition of the primary drive. I agree with jfryer as far as installing the OS in one partition and the programs in another aprtition, this is why I suggested to create a 10GB partition in the first place, this partition will be more than sufficient to hold all of the possible programs you can think of, will be easily manegeable, easy to backup (fully using a program like ghost).
Then yu can use the extended partition of the primary drive to save your programs data not to install the programs, BUT to save your data.
Step 4, Use the secondary master for your swap file, by doing so you will find that the pc will run much faster as there's no swapping between ram and the hard disk where the OS is installed, remember that if you have lot of RAM say 1GB you can do without the swap file altogheter, Windows XP will run faster and better with large amount of ram and no swap file.
Step 4, Turn off System Restore in all drives/partitons but the partition that contains the OS, you dont need System Restore on any of the partitions contanining your actual data and/or saved information.
Step 5, this is a matter of preferences of course, if you use your pc in a home environment then I suggest to use the FAT 32 Files System not NTFS, believe it or nor not Windows XP will run faster and better using Fat 32 instead of NTFS, I know that few poeple disagree with this information but it has been proven that is in fact true, NTFS is much more suitable where security is a HIGH priority, like a business environment. Also remember that a Fat 32 partition can be converted to NTFS even after the OS has been installed, converting from NTFS to Fat 32 after the OS has been installed is indeed impossible.
Finally just a matter of safeguarding your work, my recommenadtion is to use ghost and back up your full installation once you are happy how everything runs, by doing that later on if you decide to upgrade the primary hard drive or if you see that the OS has slowed down, or a virus or a trojan hard to get rid of or anything else that makes you unhappy how the system work just reformat and ghos the image you saved back onto the hard drive, 15 minutes and your pc will be exactly as when you was happy with it.
FYI, if you parttion the hard drives as I suggested you might be unhappy the way Windows XP names your drives/partition including the cd-rom drives letters, although you can certainly change them to suit your need, I do suggest you leave them a sdefaulted by the installation of the OS. Good Luck
Sorry for the long post guys.