I set up a virtual PC with a virtual harddrive. I start the virtual PC, capture an ISO image of Windows XP install disk. I navigate to the i386 folder on the D: drive and execute Winnt.exe. The Windows XP Setup screen comes up and a message states: An internal Setup error has occurred. Could not find a place for a swap file. Setup cannot continue. I have installed SP1 for Virtual PC. I have tried varying the size of the virtual drive, making it fixed. Nothing helps.

Be sure you start with the updates to VPC. Then I'd say that yes, you will not get that to work. What I would do is let the iso image boot just like a normal CD. VPC doesn't care if you capture a cd or an image. It will use it exactly the same. Might actually be faster a bit with an image. I actually can't see how you can navigate to it since there is supposed to be no OS to use unless you took a prior OS as a copy for your virtual hard drive.

Have you actually set up the virtual hard disk? By this I mean you've created a partition table in a suitable fyle system and formatted the disk before attempting to install windows. If you have failed to do so, the installation routine is failing to find a hard drive