Will this work???

For a non-gamer the 40G PS3 is plenty...and you get Blu-Ray with it. I would try for HDMI when going for the 5.1.

Also, even without HDMI you can get really good Hi-Def signals from the PS3 to the Denon as most DVDs are not yet protected, albeit the "handshake" can be annoying. Even then, without HDMI you can the that cute device called 'HDFURY'---google it.

The only difference between what you getting and what I have is that I am using an Arcam receiver...otherwise I have a 46 Sony Bravia, Comcast cable box and a 60 gig PS3.

I do what you are proposing...the PS3 and the cable box run HDMI direct to TV and then run optical from both to your Denon. I have HDMI in my Arcam and I use optical cables for the audio...reason...I don't want to run my reciever for sound all the time...often I want to hear sound from my TV for daily TV watching and sometimes for gaming. When a movie goes in or on the rare occasion with a game or TV 5.1 show, I will turn on the receiver and turn off the TV sound.

You have the right idea...one drawback to the 40 gig PS3 is a lack of wi-fi ability...at least when I bought. There are firm ware updates that affect movie playback quality...if you can hard wire or download onto a thumbdrive you will be fine with a 40 gig. It might be a consideration...I like the wi-fi ability.