well, its a good thing that you finally mentioned you need a good, not great system. so you are not the audiophile type. something about the monitor first. this fact is generally less known
HDTVs have 8 bit IPS panels (refers to the LCD screen), that means they can display 16.7 million colours. most PC monitors have 6 bit TN panels which can display about 262144 colours. that's the same as most medium budget cellphones these days. however, it doesn't look as bad as it sounds. So for a home theatre set up you will need to to buy an 8 bit monitor which is more expensive than normal monitors. Since your room is small, i think you won't need more that 32" or at most 40". don't fall for the dynamic contrast ratios and stuff like that. see a live demo of the television. Make sure you are not fooled by an HD Ready system (this problem was huge earlier, but now most TVs are full HD, so not a big issue, just look for the 1080p logo)
an HTPC is more flexible like you can plug in pen drives, external HDDs, cameras or anything else very easily & reliably. upgrades come cheap as you have to replace only certain parts like the DVD drive with blu-ray drive (just an example). further flexibility example, you can now use the on board sound for reducing your budget and later on add a sound card to improve performance.
another option you have is buying a Sony PS3 which I'm sure you haven't considered. unlike the popular notion of PS3 being a gaming console, it can act as a full fledged entertainment platform with a blu-ray drive and wi-fi built in. its one of the best players and you won't have to think of any sound card or configs as everything in it is top notch, just unpack & use.
Ultimately its a choice of price. PS3 would come around Rs. 22000. a good PC with a decent graphics card (I suggest an AMD Athlon II X2 or Phenom II X4 system for keeping a check on budget. buy a decent graphics card, geforce 9600 comes for around 5000, good one for a HTPC) would cost around 22000-25000 (without monitor or speakers). however this one would not be too good for gaming, but that, I guess, is not what you need. So my suggestion is an HTPC. get windows 7 along with your PC, enhances the look of the system & more user friendly than XP, no stability issues like Vista!
we can only suggest, you may feel we are confusing you further, but its your money & the decision has to be yours ultimately.