What you need to be aware of is that you cannot boot into OS 9 from the internal HDD if OS 9 shares a partition with OS X. OS 9 must live in a separate partition of the drive to be bootable.
Actually, I am going to contradict you here ...
Quite patently, our mileages vary. However, not content to rely on memory, I checked before I wrote, and I have no reason to resile from what I wrote.
This thread has been about a not-yet-specified Indigo iMac, OS 9 (as a cypher for 9.1/9.2.1/9.2.2), and OSs 10.3.x and 10.4.x. My post was derived from my experiences with five CRT iMacs (400 and 500MHz), an eMac 1GHz and an iBook/600 14-in., with and without OS 9.2.2 and either one of 10.3.9 or 10.4.11, leaving aside the versions between first installation from CD and now. However, I confined my post solely to two Indigo iMac/500s, Feb. 2002 and Aug. 2001, both 8582LL/A, but with serial numbers that CoconutIdentityCard cannot decode into countries of assembly or manufacture (VM209... and P1134...). The former supports Tiger and the latter supports Panther. The HDDs are partitioned 3 & 16GB and 4 & 25GB. There is a full installation of 9.2.2 on each smaller partition, but the 9.2.2 for use in Classic Mode under Panther shares the larger partition with Panther.
What I find, with and without attached and partioned LaCie d2 FireWire external drives (also with a first partition shared by 9.2.2 and one or other OS X version), is that under Tiger:
1) all nominally valid System folders show in either OS 9's Startup Disk CP or System Preferences/Startup Disk, but selection of OS 9 on a shared partition fails to boot the Macs into OS 9 (Quizzical Floppy icon). Further, selection of OS 9
or OS X on a shared partition prevents the other OS from showing in the window invoked by holding down Option during start or restart;
2) both Indigo iMacs boot into OS 9 from a CD or an external drive partition containing
only OS 9, albeit that both OSs show in the window invoked by Option when they share a partition, but the
preferred startup folder remains set for the internal hard drive. If OS X or OS 9 on an external shared partition is selected as preferred, again the iMac does not boot into OS 9, and whichever OS is selected, the other does not show in the window.
Inhibition of the other OS from appearing in the Option-invoked window also happens if Panther and OS 9 share a partition. However, both iMacs boot freely into OS 9 from a shared partition
if it can be seen and clicked on, more or less as you reported above. All available valid folders continue to show and can be selected in the OS 9 CP and OS X Preferences. It seems clear enough that, whatever the OS 9 and System Preferences selection panels show, the reality at a given moment is shown better by the Option-invoked window.
However, in the context of the Indigo iMac question posed by the OP, I continue to believe that the still-supported OS 10.4.x is the better choice, given adequate RAM and CPU speed, and that the convenience of a separate OS 9 partition on an internal HDD, for troubleshooting purposes, is worthwhile.
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PS As an aside, I should also add that OS 9.1 will no longer boot an iMac that has 9.2.x installed on its internal HDD.