When you are busy setting up a new virtual environment you will notice that dynamically expanding disks only grow in size - they don't compact automatically when you clean up your disks. If you want to reduce the size follow the next steps:
- Load your virtual pc image and from the the CD menu, select Capture ISO Image and browse to the Virtual PC additions directory, which is %ProgramFiles%\Microsoft Virtual PC\Virtual Machine Additions by default.
- Mount Virtual Disk Precompactor.iso. The precompactor will start automatically.
- When it's finished, shut down the guest OS.
- Open the Virtual Disk Wizard from the Virtual PC menu and select Edit existing disk, next choose the compact option - this can take a while to complete
For more info take a look at KB888760 - How to prepare a Virtual Server 2005 virtual hard disk file to send to Microsoft Product Support Services