In most cases you can stick an application anywhere on the Mac and run it. Certainly you can put your Windows image on the external drive. Incidentally VirtualPC is only for PowerPC based Macs - and as a result it runs very slowly. If you have an Intel Mac, get Parallels instead.

Anyone I’ve ever talked to who has tried to run Microsoft’s VirtualPC on their Mac has come away from the experience disappointed. While you can certainly use it to get Windows to run on a Mac with a G5 processor, it runs very, very slowly, and is almost completely unusable if you want to do any serious work on the Windows side. I’m not 100% sure if it would allow you to install it on the external drive (some programs need to be installed on your main OS drive), but even if you could, I wouldn’t count on it to be anything more than a novelty, unless you have extreme amounts of patience.