Accepted Solutions
If the copy of Windows XP that you have the COA for is an OEM version that came with the PC than you are not entitled to transfer it to another system, physical or vital, as it lives and dies on the system its originally install on by it EULA.
While P2V is an important, and at times, necessary mechanism nonetheless clean building will always yield overall a better built and less problematic Virtual Machine unless one takes the time to purge the P2V install of all that was relevant to the physical system originally installed and even then the virtual partition may not be aligned properly and thus affect performance dramatically.
In a use case scenario such as you've mentioned clean building is the absolute way to go and Microsoft Windows SP2 will install just fine although you may need to download the Windows XP Service Pack 3 Network Installation Package for IT Professionals and Developers if you have problems updating via Windows Update. (I'd download the aforementioned SP! 
) That said, keep in mind that there will be no more updates to Windows XP, especially security updates, as of April 8, 2014 and under the circumstances I would not allow Windows XP to have Internet/Network Connectivity after that time as Black Hat Hackers will no doubtably be targeting Windows XP for any additional security bugs they can find after Microsoft stops supporting it. I'd consider moving to a newer Windows version or abandoning Windows altogether!
1. You can add service pack into windows xp installation iso using nlite nLite - Deployment Tool for the bootable Unattended Windows installation - About.
2. Yes you will be able to P2V your current OS. Fresh install is better and P2V OS will have some leftovers installed. Just test it.
3. I opt for clean install 
If the copy of Windows XP that you have the COA for is an OEM version that came with the PC than you are not entitled to transfer it to another system, physical or vital, as it lives and dies on the system its originally install on by it EULA.
While P2V is an important, and at times, necessary mechanism nonetheless clean building will always yield overall a better built and less problematic Virtual Machine unless one takes the time to purge the P2V install of all that was relevant to the physical system originally installed and even then the virtual partition may not be aligned properly and thus affect performance dramatically.
In a use case scenario such as you've mentioned clean building is the absolute way to go and Microsoft Windows SP2 will install just fine although you may need to download the Windows XP Service Pack 3 Network Installation Package for IT Professionals and Developers if you have problems updating via Windows Update. (I'd download the aforementioned SP! ) That said, keep in mind that there will be no more updates to Windows XP, especially security updates, as of April 8, 2014 and under the circumstances I would not allow Windows XP to have Internet/Network Connectivity after that time as Black Hat Hackers will no doubtably be targeting Windows XP for any additional security bugs they can find after Microsoft stops supporting it. I'd consider moving to a newer Windows version or abandoning Windows altogether!