Audio Server Newbie...Does This Make Sense?

Yes, you're on the right track. The setup you're considering is essentially the same as mine and it works great.

There are a couple of things to think about. If you want to use the Music Hall as a one-box CD player you don't need to worry about the number of inputs on the DAC, you'll just plug the Airport Express' Toslink output into the DAC. If you're spending the money on a DAC that will be better than the internal DAC's of the Music Hall you may want to get a DAC that has multiple inputs so that you can use the Music Hall as a transport only and switch between it and the Express.

Some people claim the quality of the Toslink cable between the Express and the DAC is important. I haven't done any critical comparison but I did buy a glass cable rather than the more common plastic one.

One of the issues that is usually raised about the Airport Express is that jitter in the output from it is a problem. If that concerns you you'll want to investigate whether the DAC you're considering deals well with jitter. I've got a Benchmark DAC-1 that is claimed to be almost immune from jitter problems but other can probably give you information about other options.

Fishbone, no, the stuff you buy from iTunes is compressed. That's what most people want for portable players because the storage space on them is limited and it takes less time to download them.

That's not to say you won't enjoy the music from those songs or from the mp3's you can download at other sites. Good music that's well recorded still sounds really good. You probably would hear a difference if you're playing the files on a high-quality system but that shouldn't stop you from listening if that's a convenient way to get the music you want to hear.