Mbehner,
NO, you don't want to follow the advice of the other posters here, with exception of the original system owner, Pwfletcher. What you are trying to do with a DAC is to NOT use the stereo out from headphones jack of your apple TV.
And you also do NOT want to use the Toslink or SPDIF. Again, NOT the analog connection from ipod or apple and NOT the Toslink and NOT the coaxial interface.
What you DO want to use is USB input into the DAC. USB out of the mac tv, mac laptop, mac ipod, mac whatever. USB USB USB. Not Toslink.
IF you have ripped your songs using apple lossless, then connect the USB output to a good DAC. out put of DAC into your stereo or multichannel audio system.
As Pwfletcher posted: DAC's kind of go in the following order of quality of sound. Some other lower end than even these, and probably a few upper end I have missed. Benchmark, modified Benchmark, Bel Canto, modified Bel Canto, Wavelength Coescent, Wavelength Crimson. There is also a Music Fidelity DAC with USB. I am not sure exactly how it stacks up but given Music Fidelity's overall quality, probably somewhere in there around the Bel Canto.. a little better or worse, I am not sure.
There are probably others.
As Pwfletcher stated, start with the Benchmark, then once you get is all figured out, upgrade. Probably a good fit would be the Bel Canto for you.
And as Pwfletcher stated.. upgrade those front two speakers.
sailboat