Thought I'd share my revelation with everyone... I have the following setup.
AppleTV 1st Gen (White) running 3.0.2
Western Digital MyBook Essential 2Tb external drive (USB 2 only)
aTV Flash 4.2.1
I have been struggling for over 7 weeks now to get the external drive working as the primary storage and finally got it working now. I went through all the forum topics and couldn't get any advice that worked so, I hope this helps those that are still battling... Some of these steps might be redundant but I'm just letting you know exactly what I did to get it working.
1. Do a factory restore on the AppleTV
2. Upgrade to the newest Apple software (currently 3.0.2)
3. Link your AppleTV to iTunes and set it to custom sync one or two small files. Do a sync.
4. Install aTV Flash as per fireCore's instructions.
5. Sync with iTunes
6. Set iTunes to custom sync the AppleTV but un-tic all the options so nothing actually gets sync'd. Leave iTunes open.
7. If NitoTV has been installed go to the Maintenance menu and remove it. After removal it will ask if you want to restart the Finder. Say yes.
8. Go back to the Maintenance menu and re-install NitoTV.
9. Go to the NitoTV menu and run the smartInstaller. Make sure that it finishes with a "Successful" notice. If not, run again.
9.1 If you keep having problems FTP into the AppleTV and delete the OSX______.dmg file in the Documents folder and try again.
10. Now we need to get the external drive in shape before plugging it into the AppleTV... (These instructions are for Mac users, I have NO idea how it works in Windows)
10.1 Download the newest firmware and "MyBook Essential Software" (WD SmartWare) here. Follow steps 1 (updating the firmware) and 2 downloading and installing the WD SmartWare software as per the WD website.
10.2 In the WD SmartWare software go to the "Settings" tab, under "Drive Settings" choose "Set Up Drive"
10.3 Disable the "Virtual CD" & make sure no passwords / encryption is set on the drive. Close SmartWare.
10.4 When the drive is connected to your Mac now only 1 drive is mounted
10.5 Open open OSX's Disk Utility (By the way, I'm running 10.6.6)
10.6 Choose the external drive in the left pane and go to the "Partition" tab.
10.7 Under "Volume Scheme" choose "2 partitions" (Don't know if this is needed or if 1 will do but this worked for me)(The AppleTV will automatically re-format it as a single drive again later)
10.8 Make the one partition under a Tb (I had mine approx. 500Gb)
10.9 Name the partitions whatever you like
10.10 For the Format choose "Mac OS Extended (Journaled)"
10.11 Under "Options" choose "Apple Partition Map". (GUID could possibly also work but again, I'm just saying what I did)
10.12 Click on "Apply" to partition the drive.
10.13 Once it's finished close Disk Utility and unmount the drive.
10.14 Disconnect your external drive from your Mac. It's ready to use with your AppleTV now!
11. Power down the AppleTV (pull out the power cord) and then connect your external drive with the AppleTV.
12. Power up the AppleTV again. Once it's on do a sync with iTunes (even though it's not going to sync any files really)
13. On the AppleTV go to "Maintenance" > "Settings"
14. Choose "iTunes Storage". (At the moment it will say "Internal" next to it)
15. When the list of available drives display you will see the smaller partition being displayed correctly as i.e. 512Gb and the big partition as 1,3Gb for example.
16. Choose the small partition, the following screen will ask if you're sure you want to format the drive, say yes. (Unless you're getting scared and want to back out!)
17. Now a screen will come up saying it's formatting and copying your media over to the external drive and that it may take a while. Mine only took a couple of minutes because nothing was really synced with the AppleTV.
18. Once everything is done, the AppleTV will re-boot and you're back to the normal interface.
19. Go to the "Maintenance" menu then "Settings" and confirm that "iTunes Storage" now as "External" next to it.
20. On iTunes when you choose the AppleTV under devices it will now show a capacity of "1,859.33 GB". (The 2 partitions have now been re-formatted into 1 partition.)
That's it! You now have just under 2Tb of storage to sync with iTunes!!
I hope this at least helps someone that is boggled by the fact that your 2Tb drive shows up as 1.8Gb when you try to change iTunes Storage to external...