Confirmed. 
Several other people also experienced this problem: 
http://ubuntuforums.org/showthread.php?t=405008
The first problem is mounting usb stick or disk - initrd in alternative iso 
(xubuntu-7.10-alternate-i386.iso) doesn't contain vfat/ext2/ext3 kernel 
modules, only isofs.

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can't install alternate without cd
https://bugs.launchpad.net/bugs/178955
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