If I understand correctly, you want to use an external hard drive as the target for installation of Windows Home Server, and you want to use a USB CD-ROM to install from?
First, I would recommend you select a computer that you can dedicate entirely to Windows Home Server. When installed, it will take over all hard drives in the system, reformatting them and adding them to the storage pool.
Second, I would not recommend trying to use an external drive as your boot drive. You'll have performance issues if it's a USB drive, and you'll probably also have reliability issues.
Third, the Windows Home Server installation media should be on a DVD. Even if you have an extended CD that supports that much data, it's a DVD-ROM .iso image.
Finally, consider an internal optical drive instead of a USB drive. Again you'll get better performance. In addition, some users have found that trying to boot the installation disk from a USB DVD-ROM just doesn't work; it either bluescreens, loops on the first phase of setup, or otherwise doesn't proceed.
I'm not on the WHS team, I just post a lot. :)
