I am just starting to do something like this. From my point of view, if you don't plan to run a PVR, then just let the TV be the TV. The fewer analog components the TV signal has to go through, the better the quality will be. If your TV has a PC port, then use that instead of the TV-out port on your video card.
Your video card, while not a gaming card, should be OK for what you want to do. As far as your motherboard, it's hard to say without knowing what it is, but I'd bet it will be fine, too.
For wireless, I strongly suggest you use a wireless card with an Atheros chipset. Madwifi has its act together and it's almost pain-free to setup an Atheros card. Some of the other chipsets are, frankly, nightmares. Avoid USB at all cost.
For your sound output, try doing an online search. Something like PCCLUB or Frys (outpost.com) will probably have what you want. I prefer pcclub to Fry's. You might even be able to get it from a Best Buy or even a local PC dealer. Unfortunately, local dealers can be hard to find.
One of the moderators referred me to a package called "freevo". I haven't downloaded it yet, but I will soon. It looks like a good way to do it.
My "proof of concept" was a laptop connected via wireless through a NetGear router to my Debian Linux machine. I used InterVideo's DVD Player on Windows to play a DVD iso Samba share mounted using "Daemon" on the laptop. That's a mouthful to say, but at least it worked.
Eventually, I will have my spare machine next to the TV setup to use an IR remote for playing DVDs on that machine's hard disk as well as music. The one thing that I haven't quite got scoped out is how to play music directly to the speakers, without having the Linux box perform the TV reception function. I don't know if there'd be any sound lag if I routed the sound through the Linux box while the TV was playing, but it'd be an issue to program a remote control to turn on the TV, change the channels on the cable box, but change the volume on the PC. I'm sure there's an elegant solution somewhere.
