How to use a MBP with broken graphics chip as a server

Hypothetically, it may be possible, but the tools may not exist. The best tool I could find though was QEMU and Mac on Linux. It says it can virtualize, but I have not tested it or used it. Qemu also says its for embedded PPC - which would be like the Xbox 360, and not an older Macintosh - so therefore still not allow PPC virtualization.

I see two problems that make this a bit harder:

1. It depends on the chip you are trying to virtualize - the chip needs to have some virtualization instruction sets to allow this. Some of the G5s had this, but since I don't know what machine you have, its hard to verify. Thats what allows Intels to virtualize all types of OS now. This is pretty much what you are talking about 'its already there', but its not always there in all cases - the processor needs to know how to virtualize itself.
2. Power of the machines today - even when the first Intel Macs came out, some were just as powerful or even more powerful than the G5's of the time. Now that years have gone by, many of the tools (like MoL) look like they haven't been updated in a while, probably due to community involvement. Thats probably because too, if you really needed to run a much older machine, you could emulate the older machine faster than the older machine could virtualize itself.

For most of the people that I have seen in your situation, the easiest route is to just get another machine in most cases (and thats what I have done before, years ago). You can even get pretty powerful G5's for pretty much nothing today. I had a friend about 2 years ago just give a dual proc G5.

No reason you couldn't do this. If you have already enabled remote login for ssh or screen sharing then you are good to go! If not then as you say use target mode to amend the settings. No real reason to install a server grade hard drive, although if it has the original hard drive in it then you might want to consider replacing it with a new one before you trust your data on it.