I'd say it's worth it to follow Martin's advice first. X2CL 5035 is the latest Xecuter 2 BIOS, the most stable and packed with features. Since your box is already modded and flashed you can easily flash this BIOS to your chip with the FlashX utility available on xbins. The 5035 BIOS is also available there.
For testing the DVD drive jafster does have a good suggestion. The app DVD2Xbox (again, available on xbins) does a good job of copying games from DVD to the HDD, both in busting through problem read areas and reporting errors if it can't. You'll be able to see if the app has problems reading the disc and later test if it plays fine from the HDD. Generally if you are having a read error (failing drive) you'll get a dirty disc error I think.
3.5GB for a small game? That's getting close to a full single layer DVD. 4.5GB is approximately a full single layer, 9GB for a dual. Some small games to test with would be Pure Pinball (200MB), Metal Slug 3 (200MB), Pinball Hall of Fame (250MB) or Grooverider Slot Car Thunder (100MB). Just found the "calculate used space" feature in the UnleashX file explorer... nice.
-Whoopin'