Let's start with the DAC, or Digital-to-Analog Converter. A DAC converts the bits of data from a disk, whether CD or DVD, to analog form. The analog form is then amplified by the preamp and amp functions of your separates or receiver.
Both an AVR and CD player (as well as DVD players) have a DAC, but in the chain of equipment, only one will be used. Ideally, you would like to perform the digital-to-analog conversion as far into the system chain as possible. Theoretically, this would obtain the least signal loss of the analog signal (essentially digital signals have no loss, unlike an analog signal). For examples, many audiophiles will connect their CD player directly to the amplifier to minimize any loss associated with a preamp, that is of course that their CD player provides some sort of gain (volume) control.
If you noticed, your Panasonic DVD player probably connected to your Yamaha receiver using just one cable. This is the digital connection (there are several terms for digital - but what is going through this connection is the PCM data stream from the disk. And in this situation, your DVD player is behaving as just an audio transport, and not a player, another device is providing the digital-to-analog sound conversion or decoding. That device your Yamaha receiver. That is how your Yamaha receiver knows to play in Dolby Digital, Dolby Prologic, or Stereo modes (your right, the other sound modes at first are unique, but over time sound wrong - I agree, and I am sure there are many others on Audiogon that also agree, simple is better - in regards to surround modes at least).
If you did not use the digital (PCM) connection from the Panasonic DVD player to the Yamaha, then you would be using the stereo (left, right) analog connections from your DVD player. And these two connections would plug into and RCA audio input in the Yamaha receiver. In this case you could only obtain Dolby Prologic or Stereo modes, and not Dolby Digital. Also, in this setup, the DAC in the DVD player is now being used instead of the DAC in the AVR (though I could go off on a tangent here regarding the AVRs DAC, I'm not going to, it clouds the issue for the moment).
Now there are varying levels of DACs, and there is way too much to be said here, so to keep it simple, yes, you want a DAC that is at least 24/96, or 24/192, but nothing really less than 24/96. The numbers here represent the digital word size (24 bits) and a sample rate, 96 Mhz, or 96,000 cycles a second. A CD has a format of 16/44, and I believe DVD is 20/44 or 20/48, I don't immediately recall. And I should note that these formats are for most standard, common disks, there are audiophile grade disks that have higher numbers, but none are higher that 24/96. Now a 24/96 DAC can play any format less than 24/96, that is it can play, or decode, a 16/44 CD. And probably a lot better than a 16/44 DAC could.
Finally, I think a B&K AVR202 would make a fantastic match with your PSBs (but you will get a different opinion from many different people, the big thing you should know is to try it out and see if you like it yourself). Hey, If you hook it up, and you don't like it, you can always sell it again. Most of the AVRs we have mentioned are highly desirable and highly sellable. These four brands that we mentioned, B&K, Denon, Integra, and Rotel, have a reputation for good sound quality and reliability. If you end up selling, the only thing you might be out is your original shipping costs, $30-40 maybe.
In regards to the interconnects. There is a difference for digital and analog interconnects. As you may know, there are a few types of digital interconnects, the two most common are optical (SPDIF) and coaxial (single RCA) varieties. The optical is fairly straight forward, there is only one type of cable that can be used, an optical cable. But the coax looks just like an analog connector, but this requires a specific type of cable, and I am unsure from your previous posts if you have the correct cable. A digital interconnect (and a video cable will work as well) is not the same cable as an analog interconnect, though they look identical. Analog interconnects are usually labeled red and white (or black), digital/video cables are usually yellow. This is important to the digital signal quality being transmitted through the cable, and could have some afect on the final sound quality of your system, so it is important that you use the correct cable if you chose to use the coaxial connector over the optical connector for the connection between the DVD player and AVR. Side note, it is believed by some that the coaxial connection sounds better than the optical connections, but this may be subjective.