what is purpose of home theater processor?

While I am not an expert it goes much deeper then that.
They allow you to properly calibrate all speakers for equal sound output, distance settings are set for proper affects, crossvers are set for low frequency roll off then sends the needed info to the subwoofer if used.
Most allow specific settings for specific use, 2 channel material can have its own settings, mono another and digital information yet anaother. It many times also serves as the switching hub and "brain" of the entire rig.
Some even allow for further picture quality adjustment taking the system to an even deeper level of performance.

Chadnliz is correct, some processors can do all kinds of advanced things, but the first question you need to answer is, "do you want surround sound"? If the answer is "yes", then you'll need a surround processor or receiver, as well as all the speakers and possibly a subwoofer. If the answer is "no", then you can get a good DAC. It sounds like your post states that you have stereo, and want to know if a surround processor is needed for your "digital" sources. Correct me if I'm wrong. If this is the case, a good DAC will allow your digital sources to sound better in stereo.

What exactly is your goal?

It has always seemed to me that one would be better off setting up a two channel stereo system that plays great music and then getting a DVD player to watch movies. You won't get the special effects from action movies, earthquakes and jets going over head but home theatre is very similar to an expensive two month love affair.

The opinions expressed above represent only mine and are not intended to undermine or cast dispersions on any home theatre junkies.

I dont agree, a movie is made to be listened to in full surround and most enjoyable when viewed that way. Having said that if you have a system that excells at music it will easily perform well for movies but the reverse cant be had as easily. Some really enjoy 2 channels for movies but that seems very out dated to me, like how we watched in the 80's and earlier.
Music in general is made for 2 channel, atleast it used to be and my point is it sounds best that way because thats how it was made to be enjoyed, movies on the other hand in 2 channel is a step backwards, thats why it is is often called a "down mix" when selected for 2 channel only.