ok...
I see you like using it to play your written for OS 9 games, so really selling it when you have a good use for it to me seems kinda like a not so good idea. At that time an iMac wasn't all that poorly performing computer, and if your games are written for OS 9 then they can't have too big and bad of system requirements really, and the iMac should be able to satisfy those adequately. I agree about the hard disk thing, I don't beleive that it will recognize a disk any bigger than let's say there about 120Gb, but really even a 80Gb or 40Gb disk should do you fine, and you can pick them up pretty cheap even from your local PC shop. Then, I would suggest at some point sticking another 128Mb or RAM in it, but not necessarily right away.
To make the machine more useful right away though, you could set up the iMac to act as a file server and acess your data on the firewire disk via a LAN between the two machines. This way, your PBook never has to 'deal' with data storage. Also using it for a jukebox isn't a bad idea.
Just use your imagination and you can make this thing quite useful.