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Are you capturing to AVI or direct to MPEG2. If direct to MPEG2 choose a DVD supported resolution: 720x480, 352x480 or 352x240. If you are capturing to an uncompressed (or lossless codec) source with plans to edit and then encode, the general rule of thumb is to capture at the highest resolution and bitrate your system can support, then encode at the desired output/bitrate.
Although this is 'overkill' and takes up more space, it seems (eye of the beholder and all that) to produce better results.
Aside - if your LD is widescreen (ie. letterboxed) the easiest thing to do is capture it and encode it with a 4:3 DAR flag. If you really wanted to you could edit/crop out the black bars and make an anamorphic DVD, but it'll take a few more steps and can get tricky. -
If you capturing direct to MPEG2 then the best resolution IMHO is 352x480, 720x480 is overkill. Is it better to capture uncompressed and then encode? It really depends on the source, quaility of capture, encoder, etc. etc. When I back up old VHS tapes to DVDR I just capture in 352x480 as the quaility of my source is only so so to start with.
Display Aspect Ratio (DAR). There are three DARs you're likely to deal with:
1:1 PC
4:3 TV
16:9 film
Under the 16:9 DAR you'll find a few different ratios
1.85:1 academy flat
2.25:1 anamorphic
1.77:1 widescreen TVs
You can find out more about this whole process and anamorphic DVDs at:
http://www.thedigitalbits.com/articles/anamorphic/aspectratios/widescreenorama.html
Here's the really short verison. To get a 16:9 movie to display on a 4:3 TV and perserve the original aspec ratio you have to letterbox it. Those black parts are PART OF the movie. The video is now 4:3.
That's cool if you watch your videos on a 4:3 TV. But with widescreen TVs coming on the market why not watch your movie in the orignal 16:9 without letter boxing.
But then we'd need to produce two DVDs of each movie. One 16:9 and one 4:3 (letter boxed, and maybe a full screen verison for those that insist on it). However, with digitial media we have a better choice, anamorphic DVDs.
The video on the DVD is encoded at 720x480 and then flagged as either 4:3 or 16:9. You then set you DVD player to either 4:3 or 16:9. So let's say you have a 4:3 TV and want to watch an anamorphic 16:9 DVD on it. Well the DVD player will letterbox the video ON THE FLY for you (ie. the black bars are added by the DVD player they are not part of the video). If you had a widescreen TV the DVD player does nothing.
This allows the companies to produce only one DVD and print that little "enhanced for/ready for widescreen TVs" label on the disc
Since you're capturing from a letter boxed source you are also capturing the black bars. You are capturing a 4:3 video. So the easiest thing to do is author the DVD at 4:3 and leave the black bars in.
But if you really wanted to you could crop out the play bars, resize the video to a DVD standard resolution, and flag it as 16:9 and make an anamorphic DVD (assuming it's a 1.85:1 movie, if it's 2.35:1 or some other odd ratio it gets more tricky). In that case you DO NOT want to capture direct to MPEG2 as it's a bitch to edit (and sync issues often result).