Similar/same problem
I had the same/similar problem with a new KT last week. It would not get past stage 3 (with a disc full error) of the setup on Windows XP. strangely it would not even get that far with a windows 7 machine.
I needed to factory reset after each setup attempt. The Kobo showed as a KOBO drive in my computer before setup but lost connection and simply became Drive x after a setup attempt!
Unfortunately in my case I needed to return the KT and get a replacement.
The new one has worked well since I have had it.
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