Im hitting a very similar wall. All of my xvid/.avi movies play fine, they show up in 16/9 if they were encoded that way or show in 4/3 and the images are not distorted in any way. However, any Dvd that is played from the drive or that has been ripped to the core shows up horizontally squashed. The movies are anamorphic or letterbox and my screen is 16/9 720P native projector. There is plenty of room on both sides of the screen for the image to be stretch so that it will display properly but it doesn't. I had messed with xine settings quite a bit trying to find a fix and nothing worked. I have posted a bug report on the pluto forums, if both of you could add your particular info to that bug report as well it might help the developers to troubleshoot the issue.
@cckrobinson I am wondering where you heard about this "recommended fix"? Can you give me a little more info on the process, i might give that a try myself. Cheers.