You won't get the FAT32 option if you try installing to a partition over a certain size. I can't remember if it's 8 GB or 32 GB though. XP certainly won't let you format partitions over 32 GB as FAT32, though the reason I think 8 GB is also a possibility is because of a boot partition size/location restriction or something due to the way HDs are accessed during the initial boot up.

I use TweakUI for XP to remove the low disk space warning, I don't know the exact registry key it modifies, though you could probably Google for it