i have been doing this for a while, and it produces very nice results. i have about 200 movies on my htpc, most in the range of 1.5-2.5 gigs. i use virtualdubmod to ocnvert the video to wm9 (vbr quality 93) and mux in the ac3 files with no recompression. i did a guide a while ago, so you can search for that under my screen name. it is a bit old, but still should get you through it. just make sure to get the latest versions of the program from doom9.org
at this quality, the video typically reduces to 30-40% of the original, and it looks fine on my 36" sony tube. i havent seen these on larger tvs, so i cant speak to the results on those. however, going up to 97 on the quality would still compress to 50-60% and might look better on the larger screens. only downside of this route is that you cant really use ffdshow on the wm9 files (too much cpu), but that might change in the future when the wm9 hardware support comes along
kevin