Hi there,
I went through this whole thing a couple months ago.
you already have the space in the external drive so you should DEFINITELY rip into lossless. I ripped using the standard 128 and then had to redo my entire 700 cd collection. The quality difference is VERY noticable over a good system.
Using itunes to import to lossless works very well and is easy. there are debateable differences between itunes lossless and FLAC (look it up), but i went with itunes because it is possible to convert to other formats if necessary, and its much easier to use itunes. There are also other "burners" than itunes ( i forget the names) but again, itunes is virtually as good, and easier. (just remember to check error correction on) .
next, you must also take a look at Slimdevices.com and once satisfeid, purchase a squeezebox 3. virtually any other way of "Serving" music from a computer to a stereo is a waste of time. check it out.
here's a review:
http://www.enjoythemusic.com/magazine/equipment/1205/slimdevices_squeezebox.htmif you want to step up the squeezebox to competing with thousand-dollar cd players, check out redwineaudio.com or boldercables.com
They do the slight modifications to the squeezebox that are talked about in the review. (the mods can be as cheap as a $ couple hundred, and quality goes to excellent levels. anyway, thats enough for now.
happy ripping and listening.