Mountain Lion, Time Machine and How Best to set up an external HD?

Hello,
I'm just about to upgrade to Mountain Lion. (2011 MBP running Lion).  Before I do that I would like to back up with Time Machine.  My question is how best to set up the external HD before I back up and then upgrade.
The hard drive is brand new and I haven't formatted it for use yet.  It is 1TB in size and the hard drive on my MBP is 500GB (currently using around 300GB).
Am I right in thinking that Time Machine will overwrite older back ups if there isn't sufficient space on an external hard drive?
How would you use the new set up the new, obviously larger, external drive.  I was thinking of possibly partitioning it 750/250 and utilising the 750 for time machine back ups and the 250 for other stuff.
Any thoughts?
Cheers

https://discussions.apple.com/docs/DOC-4055

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