Acceptable achievement of Theater in the Home is as subjective as most anything else. Pool Tables are an example. We were happy with our 4ftX8ft Gandy and mid-range priced sticks illuminated by a commercial beer themed table light. I know people happy with a coin-op 3 1/2 X 7 table but others who won't play unless they have a genuine regulation 41/2 X 9 Brunswick "Crown" table and very expensive multi-shaft sticks and a tiffany table light
Projection prices have been driven down past few years. In your room I'd be very happy with, for example, a Panasonic 4000 PJ throwing to a gray pull down or fixed wall screen. IMO - you can easily have a bright, 120in (diagonal) or larger image easily within your posted budget.
Personally, we're still very happy with our 4 yr old Panasonic 720p HD projector. To our eyeballs, with a 120in diagonal image, it creates a genuine "at the movies" visual experience for us and our family and friends agree. We probably won't upgrade until the 3D technology evolves a bit more since 3D is, without question, is arriving.
Again - personal preference means A LOT!! We decided we did not want a dedicated theater room only used for sitting in the dark to stare in silence at a wall with space hogging "theater" type seating.
Our room is 17ft. X 21ft. and theater is only on of the applications it supports because it is also a game room. It is also a game room/fun room and our use of the space allows for a very open feel that can host a large party even with a bar, 7 pinball machines, coin-op type dart machines, bar top vid, foosball and a 50s model arcade baseball game.
We chose large and very comfortable bar chairs instead of "theater" seating cause dedicated, large theater seats just hog too much space. When not using the PJ they are big, dead chairs. With our bar chairs they can be arranged to watch either a movie or "the BIG game" but at other times they are great for sitting at the bar or in other room areas - near a pinball or other partying activity.
BTW - after a few years we sold the pool table and VERY glad to have it gone. It is a space hog requiring more space to allow play and we learned that very few people are "real" pool players, many don't play or are intimitated to play and only four at most can play at any time. EVERYONE of all ages can play pinball and you can trade the space of a pool table for a number of really fun game room options - like pins or foos or stand up multi-cade.
LIGHT - Again - personal preference re how much light is too much light. Movie/genuine "theater" or "at the movies" means a darkened room and at least a 100in diagonal image - probably 120in or larger preferred - size really does matter. The more ambient light in the room - specially light that shines on the screen - the more the light/image from the PJ is diluted and as the light increases the degradation becomes more visible/annoying/detracting.
I suggest you find sports bars in your area that use front projection. One near us, Gator Landing in Gainesville, uses multiple PJs. All outdoor daylight is blocked but since patrons must see to eat, socialize and play the few games there the venue has a lot of ambient light. The multiple games on the large wall screens are a bit affected by the light but can be seen and enjoyed. So, in our experience, let there be some ambient light during a party or sports watching event and while not "movie" acceptable darkness it will be great for partying. We've found that we have to keep most of our wall neon signs off - too bright for projecting but we can have the pins all lit up and some other indirect lights on and still watch a concert or sports event on the wall screen with acceptable image performance. A LOT of trial and error will tell you what will work in your own room.
We are content with a mid range Onkyo 5:1 when decoding movie soundtracks. However, since our room is a "heavy party" room we also have an older 2 channel stereo with two BIG, old Cerwin-Vega floor speakers (15in Woofs in each) on one side of the room and two old PA "tower" type speakers on the other side of the room for crankin' rock&roll. I mix both systems when watching a DVD music concert to create (to our old ears) a "just like being at the concert" audio experience (our poor, poor neighgors
Now that we're in out 60s we don't crank it up quite as much as we used to.
Hope I haven't wasted the space or your time by trying to share our game/movie/bar room experience. Some people that post here will have STRONG opinions that will disagree a little or a lot with our experience. You will have to decide what will be perfect for YOUR eyeballs, ears and taste in fun.
Best of Luck