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Yes, I just did it. With the XP Upgrade CD in, in windows 98 go to run in the start menu and open setup.exe from the cdrom drive, it'll install xp on the windows 98. Because you're not making a new guest OS in vmfusion, it still shows up as "Windows 98" but the actual OS is upgraded to be XP.

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Q: Can you upgrade a Windows 98 guest in VMWare Fusion on Mac OS X to Windows XP with an upgrade CD?
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