Have your computer hold just your ripping/burning/catalog software and store your music on an external drive. More flexibility in the long run anyway.
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My first computer was a Mac and I loved it compared to the PC's of the day. It was the mid '80's. You had Mac with a mouse and a GUI interface, or else a DOS based written text command PC. No mouse or Windows at that point. It was hard not to see what you got for the premium price that differentiated the Mac from the PC. Over time, and when Windows entered the scene, I switched to a PC/Windows because of program availability. I still like the Macs a lot. They're nice looking and have a great operating system. And program availability is not a problem anymore. However, I just can't justify the price differential for a product that goes obsolete in a very short time and has no great advantage over PC based systems. I'm afraid you're just going to have to accept that for the forseeable future, Macs are going to charge a premium. You either have to bite the bullet and pay or else switch to PC. I agree with your feeling that the price is steep for what you get.
Yeah, buying the bigger hard drive from Apple is like buying floor mats for your new car from the dealer.
160 Gb isn't a big enough drive to use as a music server, anyway. A better plan would be to buy the basic Mac Mini for $600 and keep only the operating system, iTunes and any utilities on its internal drive.
Then buy identical big external hard drives, maybe 500 Gb each. You can get those for not much over $100 each. Put your music library on one and make a mirror backup of it on the other. You don't want to have to rip all those CD's again if a drive fails.
You shouldn't need more than the standard 1 Gb of RAM if you're not using the Mini for anything other than a server. The service plan is like all extended warranties, nice to have but very expensive insurance.