Can I turn a bad video card iMac g5 into headless server?
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.