It certainly wouldn’t hurt to upgrade (2 more GB’s of RAM come to mind), but you should be able to work with what you got as long as you accept the limitations.
Here’s what I do with a PC about the same age as yours when I do songs with a couple of drum tracks (Superior), Bass (Kontakt) and maybe some organ VSTi.
When tracking I set my audio card to a low latency (256) and make sure nothing ‘heavy’ is loaded in the current project except for a simple MIDI drum loop through Superior. I commit to a guitar sound which enables me to unload the guitar sim (Guitar Rig 4) after recording a track - an alternative would be to freeze the track - but I have found that commiting to a sound are better for my workflow.
When it’s time for mixing I raise the latency to 1024 so I can use more plug ins without pushing the PC to the absolute edge. Then I usually bounce everything to WAV’s and import them in a new, mixing only, project. If I need to retrack/reprogram something, I go back to the original project.
It can be a bit frustrating, but it’s something I have come to accept until I decide to upgrade.
My guess is that your PC is pretty close to the edge. Try to freeze the sims/VSTi’s you’re not currently working on, and find the highest acceptable latency setting for tracking, then use a higher setting when mixing.
Install Cubase on your system drive, but projects should go to a different drive (as long as it’s a fairly modern internal one. External USB/FW drives could be trickier). If not for performance gains, you at least won’t lose them if Windows crashes bad and a Win reinstall is needed.