Strongly recommend you upgrade your RAM to 1 gig. 512mb will lag with even a lightweight AV like Avast.
You should also run the WIndows 7 upgrade advisor which will give an honest assessment of your hardware to run Windows 7, and detect any possible conflicts which are causing the current problem.
It is likely Windows 7 cannot see the second HDD because of incorrect BIOS settings. Check how the drive is configured in your BIOS.
Did you format the second HDD using XP? It has a different partition table and needs to be formatted from the Windows 7 installer.
You should be booting from the installer and not running it from XP. Choose Custom and use Advanced Drive tools to wipe and format the drive.