Maximum Disk Size?

I don't think FAT32 has a size limit, but your mobo might have one.

It is possible that your mobo has a HD size limit. I think the limit on Windows XP's drive size is 4 Terrabytes, so it's not the OS.

There are a couple of things to consider when choosing a format for your HD: the first is compatibility. If you want to run any 16-bit programs (which is a feat for XP to accomplish in most cases) you'll want to run FAT32. However, if you are only running 32 or 64 bit applications, want added stability, or need added security or encryption you should try NTFS.
The other consideration is speed. For drives that are 20 Gb or smaller, FAT32 will generally be faster. For drives that are larger than 20 Gb, NTFS will generally be faster.

I have two HD's in my computer and both of them are running NTFS. I haven't seen NTFS screw up as much as FAT32, especially when the HD is almost full; FAT32 has a nasty problem where it will cause 100% fragmention for almost no reason. My reccomendation: go with NTFS.

As Dead_Hood suggest, use NTFS.

Check your mobo's manual if there says anything about maximum size of HD's.
Go to the manufactures homepage and check for an BIOS's upgrade. Sometimes that's all you need.

But, you aren't going to have a big 120 Gb partition, are you? If you are installing the operatingsystem on this drive, I suggest you make 2 partitions. One smaller for the Windows and programs, and a bigger for all your other files.

my partitions are setup exactly like u said Swedix

There used to be a problem with HDD size, you used to be able to have hard drives no bigger than 8 GB, but I don't know if that was a FAT32 thing so much as a Windows 98 thing.

Just to be safe, either limit your system partition to 8GB or use NTFS (which is superior anyway).