wish to instal LION on crashed disc

My Mac iMac i7 8 gig 10.6.8 crashed, it was running on an external boot drive for 2 years, but just crashed.

Diagnostics said repair it! so I repaired it and it passed √√√ but it still won't "boot" - so I booted from the internal drive - then updated it to latest OS 10.6.8 and am downloading LION (might as well bite the bullet).

Yes, I've been running my Mac on an external drive whilst the internal just sat there - now the internal is up to date - I can instal LION onto it BUT... here is my question.

Can I instal LION on my external disc which is now OK√ but just won't boot (but it has all my files and programs) - that way I am hoping that my old OS will be upgraded to LION and I will have all my programs intact - otherwise I will be installing LION on my internal and have to rebuild ALL my programs.

So

Can I instal LION (whilst booted on internal drive) on an EXTERNAL drive and UPDATE the OS on it ?

or

do I have to find a way to boot from my external so LION know that's the OS I want to upgrade

and

Can I instal LION onto my external drive without wiping everything?

Thanks all!

ps. I have backup with apples Time machine

Yes I did that when testing Lion.

Choose the right option while Installing. I think its call install in place.

P.S. OSX makes extensive use of the drive for virtual RAM. FireWire/USB is considerably slower than internal SARTA, having the speed of a i7 then slowing all the IO down to FireWire Speed is very sad.