The easiest way to do this (as long as you have enough hard drive space) is to extend your existing VHD using VHD Expander which gives you two VHD files. The newly extended file will take the name of your existing VHD. You might want to Defragment, Precompact, and Compact your VHD prior to extending your VHD.
In Virtual PC 2007 go to Settings.
- Select your OLD VHD as Hard Disk 1
- Select your newly extended VHD as Hard Disk 2
- Boot your VM
- Open an Command Prompt
- Run diskpart
- From DISKPART>
- Execute LIST VOLUME
- Select your new VHD volume by executing SELECT VOLUME <N> where <N> is your new VHD most likely 2
- Execute EXTEND
- You should see a success message. If not you may have to recreate your extended VHD due to an error in the process.
- Quit Diskpart.exe by typing EXIT
- Shut Down the VM
- Remove both VHD files from the Hard Disks list
- Add your newly extended VHD as Hard Disk 1
- Boot your VM.
- You will get a Windows Newly Added Hardware message after a short time.
- Reboot the VM when prompted
- Start using your newly extended VHD!
Here is Microsoft's information on extending volumes using Diskpart.exe: http://support.microsoft.com/kb/325590
Enjoy!