The software development department where I work writes all software in a Virtual PC environment. Depending on the project this can be Windows 2000 with Visual Studio 2003, Windows 2003 with Visual Studio 2005 or even Linux with Eclipse.
The desktop machine where the Virtual PC with the development environment is running is still a basic office machine with the regular office applications and Virtual PC 2004. Based on the project the development environment is chosen. Sources are stored in a central SourceSafe repository. So it's very flexible.
Recently Microsoft released the white paper "Microsoft Virtual PC 2004 Development and Debugging". This document gives a lot of tips and tricks an explains in detail some of the more advanced areas. It's a must read for developers who want to start developing with Virtual PC but also a great startpoint for those that just want to try out Virtual PC.