Krell Showcase 7.1 DACS

I did not say that ext. dac is necessary better.....it all depends on the dac quality.
1) if you just want to listen to your digital files through your Krell...,you don't need ext. dac (that would probably set you back a least a 1G). Krell's dac is just fine but don't think for a second that becouse it says Krell it can not be better.....it can.
2)how much can be gain depends on how reviling is your system and how thick is your wallet.
3)No...if you are gone use analog output connection from digital source (CDP, PC, Media Player, etc) to Krell , signal is already converted from digital to analog by the source (quality depends on the dac of the component). Krell has a very good analog section, and if I am not mistaken (it has been a while) you can use pass trough in-puts on Showcase processor for straight and unpolluted by other circuits path to your amplifiers. Ofcource you can still control volume etc. If your source has a crappy dac and you don't want to take chances of trowing it out the window - use digital out to Krell. Then Krell's dac will take care of the rest.
3) if I were you, I would do a little search on Audiogon forum pages and find as much information about PC, Sonos, Slim, iMac mini etc. used in Hi-Fi systems as possible.
There is a lots of good treads and tips, ...just look.
4)Some guys were able to achieve better sound from their media files and music servers then from their reference CDP. It takes knowledge and some money to get that kind of performance....but it is definitely possible. You can choose that road if you like. But that is another story.

Ok, so do you think the Transporter's DAC is better than the krell DAC, because if it isn't then I should just use the squeezebox.

Transporter is a very good for the money, but take my opinion with grain of salt since I do not own one. I've heard it more then ones and it did sound pretty good.

Trasporter is an easy recomenndation for ease of use and sound quality.

Another option would be Squeezebox with ext. DAC like Scott Nixon's tube dac (about $600new or $400used) with seperate power supply to take the harsh, edgy sound usualy associated with digial reproduction at this level.
This combintion would be a very good starting point for you in digital files playback system with the room to grow.
You could also use Sonos with similar results.
Both Squeezebox & Sonos can letter be upgraded with Empirical Audio Pace Car to reach reference quality sound.
I was able to expirience it first hand during CES SHOW few weeks ago in Las Vegas. I was so impressed with Steve Nugents' product that I wanted to pay for it right there & then. He was not ready to sell his show demo unit, however the beautyful woman that was with Steve (Please forgive me Steve for that comment) was more of a "Business woman" and eager to make the sale. To bad I was preaty bussy myself and never got around to go back and close the deal. Maybe some other time.

So there you go. You have few options to think about. I won't tell you what to do. It is your call and money.
However starting small with good foundation for improvement would be my best advise. Unless you want one box "ready" and easy to use product like Transporter, then you are all set.

Mariusz