Does your friend's 360 have a HDMI output? It must be a recent one, since the one I have does not have HDMI (I'm really tempted to swap it for one that does, since I use it to play HD DVD).
RCA is the worst connection you can have in terms of quality. It will be blurry, full of interference artifacts and the colors will not be that great. The next best thing is S-Video. Then component. And finally, HDMI.
I think for most people, a 32" to 40" screen, with a simple 5.1/7.1 system (the ones with small speakers, not those floor standing ones) will be good enough. The next bracket would 50" to 65" + AV receiver and 5.1/7.1 set of high quality home theatre speakers/subwoofer. Then you have people using front projection and massive screens, in a dedicated home theatre room (complete with proper seating, and blackened windows).
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