I have just come across the same problem.
I just did a fresh install of XP and SP2 to fix some non-related problems.
I reloaded everything to just like I had it before and everything works wonderfully now...except...
Now when I try to play Vice City I just get a spinning CD mouse icon, then nothing.
In task manager I can watch gta-vc.exe start then just disappear.
I used to run vice city from a disk image (.nrg) using Daemon tools 347, but this suddenly doesn't work now.
(Yes I made the images myself from a legit CD that I paid for)
As far as I can tell, NOTHING is different than before except that vice city seems to know it's not a cd in a drive!
I suppose I could just pop the cd in and out, but this is really bugging me.
I've checked on just about every VC forum and tried everything suggested...
I've tried the latest nVidia drivers (61.77)and the 2 I've used previously (mainly my prefered 53.03 which used to run it fine).
I've tried fresh reinstalls. (and I tried deleting every reference in the registry)
I've tried the 1.1 patch.
I'm pretty sure that it's not an SP2 problem seeing as how I had SP2 installed before.
I was suprised to read that VC was a hard one to backup.
I made a copy with Nero and it worked fine.
For me it was the easiest of any game I've ever backed up... until now.
How does the .bwa file work? Is it for the writing of the image with diskdump or the usage of the image?
Any other suggestions on this matter would be GREATLY APPRECIATED!