You can put them wherever your want (usually E: or F:). You need to alter the .xml file to reflect the location and the name. Then just proceed to the selection and push A. There is a tutorial ono editing the xml file (use notepad or another text editor). Goto XBMP homepage and download the guide.
Mine looks something like this - movies on my harddrive are in f:Movies and I see the folder as Local. When I select Local on the menu (rather than my relax server - the next entry) I see the folder heirarchy and files in the Movies folder:
<videos>
<share>
<name>Local</name>
<url>f:Movies</url>
<cachesize>8192</cachesize>
</share>
<share>
<name>Server</name>
<url>
[email protected]</url>
<cachesize>8192</cachesize>
</share>
</videos>