I am sitting 14' from a 125" screen.
You need to determine where your sweet spot will be, the seat that you will be sitting in for the majority of your viewing and use that as your baseline. How far back will that seat be? This calculator will also help:
Go with the THX recommended viewing distance. I know it seems big now, but you adjust quickly to it. I went too small with my first screen (100" screen sitting 12.5' away) and once I got used to it, I really wished I would have gone slightly larger.
Blu-Ray looks amazing with the THX recommended distances.
IMHO, I would get a projector and screen.
As for audio, I am not a fan of home theater in a box systems. They usually have very small drivers, are cheaply built, and give you just adequate sound.
On a budget, I would start with some of these speakers, and an entry level receiver.
Left and Right Speakers:
$100 after promo code
$50 after promo code
For $120 and some more mid bass repsonse you could get a pair of these floorstanding speakers for $120 after promo code:
The speakers are a screaming deal and were designed by Andew Jones who is a noted speaker designer who was previously known for designing much more costly speakers. I own speakers that cost 10x more than these and can tell you first hand the Pioneer speakers are no slouch. They easily can hang with speakers that cost 2-3 times more.
As for the receiver, if it was me, I would step up to this one that has room equalization (Audyssey MultiEQ):
but that will run you slightly over $200 with shipping. Still, I would spend my money here before worrying about room treatments. You will also need a subwoofer, but save up for that and get a decent one. Plan $200-300 for one.
If you can wait a few months there should be some awesome deals on projectors for the holidays. You could probably save $200-300 by waiting I suspect.