If your sister DID upgrade her PC with the disc before returning it back to you, then you need to sell it to her--or give it to her. It's hers. Microsoft only licenses each Windows CD for ONE computer. Therefore, only the FIRST PERSON who has installed and registered it (your sister) can use it.
If your Windows XP is a legal CD that you bought in the store and that is an authentic Microsoft Windows XP CD, then it has a sticker inside the packaging that you will need to give to your sister and she will need to stick it on her computer to make even her copy legal. It's called a "Certificate of Authenticity" http://www.microsoft.com/howtotell/content.aspx?displaylang=en&pg=coa. You cannot ask her to uninstall it so you can install it legally on YOUR computer, because she has probably already registered it, and when she did so, Microsoft gets more information about your computer than you think they do. They CAN tell if you are trying to install and register it on a second computer.
If you do try to install the same copy on your computer, nonetheless, and if you are both online at the same time, you could BOTH have your computers shut down--unusable, and you will both get a popup window telling you that because you have violated the license agreement, Microsoft has frozen your computer and the only way to unlock it is to call them and explain why more than one computer has the same license.
I am not making this up. I was working on a lady's computer--fixing it for her--one night when that happened to me. I asked her, "What's the meaning of this?" and then she told me that her son had set it up for her, and he used HIS copy of Windows. Then he got mad at her for some reason, and called Microsoft and told them that she had somehow put HIS copy of Windows on her computer, so the next time she logged on--to let me fix it--we got that message. I don't know HOW they did that, but they did.
I cloned her hard disk and took the clone home so I could work on it and see what I could do. It was locked so bad, nothing worked. Even when I put it in my computer as a slave to try to retreive her pictures and document files, I couldn't get anything. I couldn't even format it. I just got a message saying that because it was locked, it couldn't be formatted. I ended up removing all of the partitions, wiping the hard drive clean, and then repartitioned it.
When I told her she would need to buy her own copy of Windows XP (this was before they had Vista) she told me she didn't want to do that, so I told her to find someone else to work on her computer. I will not work on a computer that is not legally licensed because I don't want to get caught with it. I don't know what she did after that. I did hear, however, that her other son made a computer for her and set it up for her. I hope he didn't try to re-use HIS copy of Windows on it!
Another thing I see is that you say "I assume I can now safely delete the XPSP3 file I created". I don't know exactly what you mean by that, but once you install the XP-SP2, then you need to immediately go to Windows Updates (or better yet, upgrade it to Microsoft Updates, so you get more of the updates you need) and open it with the Custom button, rather than the Express button, because then you will get ALL the updates, rather than just what they say are essential ones. Download all of the SP-2 updates, and then install Windows XP SP3. Then you'll need to go back several times to do all the updates that need to be done since SP3 has been released.