I don't know how to increase the size of the existing drive either, but as _?_ suggests, you can create a second virtual hard disk. You can create it and 'format' it however you like, then go into the stats for your virtual XP and add the new drive. You can have up to 3 virtual hard drives at once I think. It will simply appear as your D: drive within XP.
Then you should be able to install the program on the new virtual drive.