|My friend (who knows more about things OS wise) says that I need to reformat my hard drive all together, and partition it in half via windows CD.|
Is this true? Or can I install the Windows 7 CD on the patition without having to reformat?
I would ignore what you friend is telling you in future. He doesn't know what he is talking about. All you need to install a second OS, any OS in fact including Linux if you so desire, is some free space to put it on.
As Jam say, all you need do is install Windows in the free space and a boot manager will be set up automatically.
Even if you did reformat you would end up in the situation as you are now, with two partitions and Windows XP on one and nothing on the other. Whether you created the partition with Windows XP or some third party partition manager makes little difference.