"Does the DAC connect to the preamp via analog in or digital in to the receiver?"
Analog in--hence digital-to-analog conversion: signal goes in digital, comes out analog.
"I am also assuming that the DAC handles the digital signal in such a way as to improve or expand it?"
It can sort of, although more normally look at it as it simply does a more accurate job than a lesser dac of converting the bitstream into the analog signal. But you're more or less right.
"Another question I have is what happens when I am playing a DVD?"
I think you'd have to run the digital into the receiver to get the surround, someone may know more there. May need a cable swapper/switcher or you'll have to do it by hand or your DVD should/could have internal DACs and you'll feed all the analog straight to the receiver--DVD owners will know more here. I would imagine this last approach means five or six analog cables running to the receiver from the DVD??
Analog in--hence digital-to-analog conversion: signal goes in digital, comes out analog.
"I am also assuming that the DAC handles the digital signal in such a way as to improve or expand it?"
It can sort of, although more normally look at it as it simply does a more accurate job than a lesser dac of converting the bitstream into the analog signal. But you're more or less right.
"Another question I have is what happens when I am playing a DVD?"
I think you'd have to run the digital into the receiver to get the surround, someone may know more there. May need a cable swapper/switcher or you'll have to do it by hand or your DVD should/could have internal DACs and you'll feed all the analog straight to the receiver--DVD owners will know more here. I would imagine this last approach means five or six analog cables running to the receiver from the DVD??