A new bigger Ultra-ATA 3.5" drive will likely be cheaper than an enclosure. Note that you can't use anything bigger than 128 gigs in that Mac, but 120 gig UATA are cheap by now. The enclosure is easier though, as installing an HD in that iMac is not exactly easy. Definitely doable if you're not too hamfingeredm but be patient. Remove the VGA cover, unscrew the bottom cover and unscrew the shield (the net-like thingy) and you can see the drive cage. Keep track of which screw goes where.
Getting the data off it first is easier: upgrade the MacBook first, you can copy the files to it using Firewire target disk mode.