While I have done exactly the same thing using Acronis True Image, I have not used the Windows 7 Backup and restore utility to do this so I cannot say for sure if it will work as advertised. I would certainly be interested in hearing your results upon completion of the task.
I would say go for it, I don't see any jeopardy if you follow the steps that you've outlined above, your original 120 gig will be safely set aside for emergency purposes.
I think you have one extra step, step 3 Install Windows 7 on the 800 gig drive, I think is unnecessary, since you can create a "System Repair Disc" also from within the backup and restore utility, which should allow you to boot from that and restore your image from there.
I am very interested in...