Is my hard drive dead? OS install fails but no hardware probs detected

The white imac I purchased in 2001 has been making squelching beeps during startup on occasion, sounding as if it's having trouble getting the disc spinning. Usually it comes around, starts whirring & booting up fine, though occasionally it'll fail and flash the question mark and I'll then have to turn it off and try again. Finally, though, it seems to have died for real. It hasn't booted up since last night. The flashing ? alternating with the OS picasso logo is all I get now, without exception. I've tried booting up from the software install disk, but when I try and reinstall it tells me that it cannot find a valid volume on which to install the OS. However, I've run the Hardware Test CD and the computer passes all of its tests. That confuses me a little bit-- maybe shouldn't. Should I assume the harddrive is dead and try take it in to have it replaced and try and have the data recovered (there were a number of audio sessions that were too big for me to back up), or could this still possibly be a software issue? Also, I'm wondering if it's possible to purchase an external harddrive as a replacement and just run the OS for my imac off of that? That might be a wiser investment than buying a new internal HD for an aging computer.
imac CRT   Mac OS 9.2.x  

You might want to go find the iMac (CRT) Discussions a little farther down the iMac page and seek help from follks using your same computer and OS. Everybody here has a brand new iMac Intel Core Duo, and some of the folks here may have never seen Mac OS 9! I personally haven't used it since about MAY 2001.
http://discussions.apple.com/category.jspa?categoryID=133

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