I know this sounds stupid, but have you checked the state of the CAT5 cables and the connectors? I had this before, when one of the connectors was a bit loose and didn't make a good contact all the time, breaking / slowing down the connection.
I am using Daemon Tools 4.03 and use USB flashdrives a lot too and never had any problems. Is your pc stand-alone or part of a network? If it's part of a network, have you got any mapped drives? Windows will assign a letter to your USB flash drive that might be in use by a mapped drive (happened to me before, picked my brains a while to find out the solution). Try disconnecting all mapped drives and then plug your USB drive in. Hope this helps.
From my understandings, SP3 will be a sum of all updates to the date of release. Since I am up to date with windows update, why bother installing SP3? Of course, it has some other rewritten files too, isn't it?
In exactly the same file: outlook.pst. And I found that you can copy the outlook.pst file off the dead hard-drive and paste it to the new installed drive provided that you have installed outlook and started it once.
Have you tried to log into safe mode? I would just save any / all documents / pictures / music / video off that install on a cd or dvd, format and do a clean install.
I had the very same problem some time ago, turned out to be one faulty RAM module, so here's what I suggest: run memtest86 and see... Also you may try to clean the dust that accumulates around the CPU and the RAM slots.