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With the information I could find, there isn't any dedicated DSP chip to decode the video, and although the GeForce Go 7300 GPU it uses can accelerate video decoding, it really isn't very powerful. You have to get to the 8xxx series of GeForce GPUs before they can really help decode newer codecs like h264.
Anyway, if the the lack of power under the hood is the problem Apple won't be able to improve the quality in the future. I could be wrong though.
A derivative of the h264 codec is used to make Blu-ray discs. Don't underestimate this codec. You will be impressed when you see Apple's download quality.
We all know you can't hear all of the audio on a CD. 95% of all humans can't tell an AAC ripped at 160 kbps from the original.
Same goes for video. We don't see every blue patch of sky, our brains just register blue sky and silver airplane. In a static shot we just need one frame of the background, and so on. If the codec is good the bit rate can be lower and the h264 codec and it's derivatives are very good.
Second, you say you compress your DVDs down to 1.5GB and the picture quality is good enough for you. Well if the "average" movie is 2 hours in this scenario that means you are using a bitrate of around 1700kbps. Apple is using 4000kbps, which is about 2.3x higher. The problem is that 720p has 2.7x as many pixels as 480p. So even your own rips are using 14% more bits per pixel than Apple is using.
I'm pretty sure it can be said with certainty that Apple is pushing the lower limits of image quality.
http://www.buzzillions.com/prd-260217-sony-blu-...
One guy said "Great design gives it a sleek look. When turning it on, it takes longer than a minute for the tray to open up. I have heard this before so it may be common for these types of DVDs. With the HDMI connection, the picture is very sharp! I definitely noticed a difference in DVDs to HD Blue Rays.
Disadvantage on all HDMI connection is that you don't get closed captions signal through it. If the DVD doesn't have subtitles, then you need to use a different connection and the quality reduces, big time.
The manual section on hook-up is confusing a little on the variety of choices. HDMI is too simple and yet the manual shows to many wires with options that won't make sense to some users. You need to figure out the settings if you want PCM audio, mix-down, etc. You need to know which quality is better.
First couple of days on using it, it locked up once watching a movie. I had to unplugged it from the back to restart it. It could be a dirty DVD but it hasn't happened again.
My biggest peeve is when you turn off the DVD and want to continue watching where you left off next time, you at the beginning of the DVD again.
Not so sure about improvement on audio quality because I can't imagine audio sounding better than regular DVDs."