There are several ways of doing this depending on your personal preference and installed tools (like Update Manager). I opted to do a complete reinstall of my hosts to get a clean and known configuration, but there are documented ways to upgrade existing 3.5 installs. The documentation to read would be this one: http://www.vmware.com/pdf/vsphere4/r40_u1/vsp_40_u1_upgrade_guide.pdf
Hope it helps!
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