It looks like I spoke too soon regarding midrange video cards. A rebate has come along that gives us a Radeon HD 4870 1GB for $140. In addition, it has a $15 combo with the OCZ DDR2 RAM I've been suggesting. The shipping isn't free, but the overall cost will still be less than the GTX 260 I suggested earlier. This card will also outperform the 260. Since this is a 1GB model, it will do well even at very high resolutions. It also has integrated HDMI. It even comes with a free wireless mouse!
While the HD 4850 is still the best bang for the buck, let's assume you want to spend a little more than $424 on a gaming system. Perhaps you want a processor that's more overclockable, better cooling, and more power.
Processor: AMD Phenom II X3 720 Black Edition - $139
Motherboard: ASUS M4A78 Plus - $70 (after $10 rebate)
RAM: OCZ Reaper HPC Edition 4GB (2 x 2GB) DDR2 800 - $30 (after $20 rebate)
Video Card: GIGABYTE GV-R487D5-1GD Radeon HD 4870 1GB - $140 (after $20 rebate)
Case: NZXT TEMPEST Crafted Series CS-NT-TEM-B Black Steel - $90 (after $20 rebate)
Power Supply: NZXT PS-NT-PP600-R 600W - $70
Hard Drive: Western Digital Caviar Black WD6401AALS 640GB - $75
Optical Drive: LG Black 22X SATA DVD+-RW - $24
CPU Heatsink & Fan: XIGMATEK HDT-S1283 - $27 (after $5 rebate)
Discount: $55 (CPU/MB, VC/RAM, Case/PSU combo deals)
This build is basically superior to the bargain build in every way. You have a faster processor, better video card, more power, more hard drive space, and a case with more room and cooling. You'll also notice that I included a heatsink and fan to give you more flexibility when overclocking the processor.
At stock speeds, the gaming performance of this processor will be almost the same as the Phenom II X2. However, this one will give you greater gains when overclocking, and that's what you're expected to do with this build. The Xigmatek heatsink will allow you to overclock to your heart's content while keeping your CPU at reasonable temperatures. The NZXT Tempest case is known for its excellent airflow, which will also help with the cooling.
And it's a good thing we'll have decent airflow here because it sounds like the 4870 GPU will be running hotter than the 4850. You might also want to see if ATI Tray Tools will allow you to adjust the fan speed - the reviewers said it likes to run at max. If you can find a Thermalright HR-03 for a decent price anywhere, you might want to consider getting it. Newegg doesn't carry them anymore. However, Newegg does carry the Arctic Cooling Accelero S1 Rev.2 for $25 plus shipping. Either of those heatsinks are able to passively cool this video card to great effect, though you can also attach a quiet fan if you wish. A silent GPU would actually turn this system into a decent home theater PC.
The 500GB version of the Caviar Black seems to have gone up to $70 now. For $75 you can have the 640GB version, for $80 you can have 750GB, and for $100 you can have 1TB. I suggested the 640GB version here, but get whatever you like. There don't seem to be any amazing combos, though you can still get the deal with the 500GB version and the Rosewill case. If you don't like any of the combos, be sure to at least get a free SATA cable combo because it won't cost you anything. It does have combo deals with OEM versions of Windows Vista, such as $20 off Home Premium x64 which is my recommendation.
The hefty power supply will give you much more flexibility with your system. It has a $30 combo savings with the NZXT case, so they're a great pair.
Overall, this system shows you several inexpensive upgrade paths you can choose in order to enhance the bargain build to your desires. You can mix and match as you please. For example, the biggest difference in performance would come from simply popping in the better video card for an extra $50.
If you just prefer silence you can get the heatsink, case, and PSU for an extra $110 while keeping the 4850 and X2 550. You also might consider the cooler and quieter Caviar Green hard drives. That would make a nice HTPC, and for only about $550. Maybe I'll dabble more in HTPCs later. Anandtech has mentioned they will be covering the topic soon, so it will be interesting to see what they have to say.