It will with Dolby Digital audio on some/many 5.1 programs, if your get digital sound service.
2) Will the Toslink optical digital input on the receiver be acceptable or does the "DTV component" video up conversion come into play here and what exactly is the "DTV component video input" used for?
The Toslink is for digital audio, so it should work, yes.
Component video is for video from the cable box to the TV in component format, 3 color, 3 cables, less interference and no need for separation by TV.
3) I don't really understand the digital audio output on the receiver. Do I need to hook up anything from the receiver to the TV besides the S-Video cable and my red & blue monster audio cable (please don't make fun of me, I bought them a long time ago) to get the proper digital audio/video signals I am looking for?
Not sure where you would send that digital audio out to either, so don't use it. If you have component video out on the cable box, you can hook that to the TV. For DVD movies, you send the video to the receiver, or to the TV. If you have another component input on the TV run it, or S-video.
Or, you can use the receiver to switch the video inputs to the Tv, then you only need one run to the TV. BUT, this will depend on that receiver, what video switching capability it has. I don't know off hand, unless you have a link to that component.