Which is better: separates or receiver?

By a wide margin the best bang for buck is a receiver. Denon, Onkyo/Integra, Yamaha, Pioneer/Elite, Sony, etc. all make perfectly usable products that will stand up to all but the most intense sonic scrutiny. Be sure to match them to reasonably efficient speaker whose impedance doesn't drop below 6 ohms. My recommendation is to not go over $2,000 on the receiver. Theoretically, separate components can provide superior performance when compared to a receiver, but unless you're willing to provide a dedicated room with extensive sound treatment these advantages will not be realized.

Slingshot, your points are well taken, but please answer the following: Being that the room is the single largest determinate of sound quality, why would anyone spend large sums of money on equipment if they are going to not address room issues. Using bang for the buck as the guideline, money spent on room treatment is probably a better investment than cables.

The subject of room treatment is too big for this format, but let me give an overview. Low frequency standing waves need to be addressed. Speaker placement and corner bass traps are effective for this. Early speaker reflections from nearby walls, the ceiling and the floor need to be attenuated. At the same time you must be careful not to overdamp the room. These points apply to 2 channel as well as HT systems. The Stereophile Guide to HT has a series of excellent articles that go into great detail about acoustic problems and their solution.