Might be that it is looking for the old Windows files that are no longer there as you formated the drive. I know I had a similiar problem when trying to install an upgrade version of Windows 98, but think it actually did tell me it couldn't find the files.
One more thing, did you leave a MBR on the drive? If it is just rebooting to the CD drive might be a problem with the MBR, or the boot order in BIOS. I would doubt BIOS would be the problem though. Every time I installed XP it would reboot and ignore the CD and finish doing its installation process.