This
tutorial is something I tried out and it works brilliantly.
The upsampling does cause it to take quite some time... It took about 25 hours or so on my 933MHz G4 tower, but the result was flawless.
He's using 2250Kbps for a standard definition anamorphic widescreen DVD on Mediafork. I used the same settings he recommended and the color, clarity and contrast were excellent. The file size for 1h 50m was about 1.86 gigabytes.
It's a bit extra work with the 2nd step but that takes only a few seconds to set up and maybe a minute to transcode into the appropriate container.
So far it's the absolute best results I've seen with SD over AppleTV. Additionally, the AAC 160Kbps is pretty sufficient for the 2 channel downmix. When demuxed back into 5.1 channel Dolby Surround analog, the matrix decode produced pretty decent channel separation in my receiver. I'm using a Sony STR-DA1000ES receiver with dual 32-bit DAC's so results with Dolby Surround might vary but there's no reason 160Kbps AAC can't be sufficient for Dolby Surround playback... and you're limited by the fact that 160Kbps appears to be the max bitrate for the AAC component of MPEG-4 AVC that AppleTV will support. That may change with later software updates.