I personally have been using Nero recode, preserving the 5.1 surround by using AAC 5.1, and encoding using h.264 @ 1800 bit rate. The resulting file is approximately 2.7 GB for a 2 1/2 hour movie, which includes the 5.1 AAC, h.264 video, and subtitle track (track 3). The image quality is absolutely damn near DVD quality.
I am using a PC for the program, a 1.6 Core 2 Duo w/1 GB of ram. With 2 pass encoding, it takes about 3 hours a movie. I let this run over night, as I can queue files.
Some important notes. Firstly, the Apple TV CANNOT output 5.1 surround. My receiver picks it up as stereo from both analog out and optical out. I can force Dolby Prologic, but this isn't true 5.1 surround. I have left the 5.1 soundtrack in hopes of a future patch that will pass this information through. Secondly, the subtitle track is not usable from itunes or AppleTV, but again I hope for a future patch.
Lastly, iTunes 7.1 CANNOT add tags or album art to MP4 files with 5.1 AAC. Hopefully this will be patched in a future release.
I have used the above settings in hope of future proofing my encodes. I hope this helps you.
tv's 5.1 capability (or not) has been kicked around in various threads but I have yet to see anyone say they're actually done a real-world test, e.g., playing an iTunes movie (known to have AAC surround sound) to see (errr.. hear) if it will actually play back in discrete 5.1 surround via 
