Won't work, at least not directly. You'd need to have a computer sitting between the HDD and 360 to basically translate. And if you have to do that, you may as well just hook the computer directly to the TV, unless for some reason you're just dying to use the 360 controller as a remote.
Long story short, game consoles make horrible movie players. Sony used the PS3 to help push it's bluray format over HD-DVD, and Microsoft really only added video playback (beyond DVD) to the 360 as an afterthought. The main focus of each is still gaming, and everything else is a distant second. Use them accordingly.
What you may want to consider looking into, are things like Western Digital's TV Live product. It's basically a small set atop box that functions as a media player. There's even a version that comes with a 1TB HDD to store content on, and of course you can always connect an additional external HDD or two via supplied USB ports. There are other competitors out there to this such as Apple's AppleTV, Google's which I can't remember the name for, Asus has the O!Play, pretty sure Seagate has something, there's the Boxee Box, etc. These all accomplish the same basic goal but will do so using a fraction of the energy of a 360/PS3 or computer. So relative to what you'd be paying with some other solution, eventually these products will pay for themselves in lower utility bills every month. A good middle ground type solution is an Apple Mac Mini. Small, fairly energy efficient (max power draw of the Mini is about the same as a 100W lightbulb), and quiet. You can stash it out of the way somewhere, it has an IR sensor standard for a remote, and you can load a somewhat more capable media center app like XBMC onto it. It has HDMI for digital audio if you have a surround sound system. Don't go getting ideas about upgrading anything more than the RAM on that thing, but there's 4 USB ports so you should be able to connect plenty of external drives for storage.
It should also be noted that unless your friend is extremely well to do and buys a ton of DVDs, the bulk of his collection is likely pirated/illegal. I'm not here to judge, just say that copyright laws in western nations (like those where English is the primary language) have been increasingly favorable to copyright holders. Most of Disney's cash cows like Mickey Mouse SHOULD have passed into the public domain a decade or two ago, if not for Disney pumping millions of dollars into brib... I mean "lobbying efforts" and "campaign contributions" to the US Congress. And companies are getting increasingly nasty about protecting their "investments" by suing people. If your friend hasn't gotten at least one or two DMCA notices, then he should count himself extremely lucky, and you should assume that you will not be as lucky. Punitive damages in the US for each copyright violation can be around $5,000 IIRC. So you download a single song off a file sharing network, it could cost you $5,000 plus legal fees. Each additional song would be another $5,000. So, before you get too gung ho over this idea, you may want to consider if it's worth that kind of a risk to you.
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