I just purchased KOTOR 2 and could not get it to work on after I installed the update. It would give me a generic Windows crash even before it would access the CD. After a lot of monkeying around, I got it to work by setting it to run in Windows 2000 compatibility mode.
Go to C:\Program Files\LucasArts\SWKotOR2
Right click the file swkotor2.exe and select Properties
Then select the Compatibility tab, check the box and select Windows 2000.
I have a brand new Intel Core Duo machine running Windows XP SP2 with all of the latest drivers. My video card is an nVidia GeForce 7600 GT.
Hope this helps some of you who are having problems.