You should read up on anamorphic widescreen encoding. Here is a start: http://en.wikipedia.org/wiki/Anamorphic_widescreen
You might also want to read up on PAR: pixel aspect ratio
SAR: storage aspect ratio and DAR: display aspect ratio
If you go to dvd video, using something like AVStoDVD, it will set the DAR to 16:9 for you and you will get a PAL dvd with a frame size of 720 x 576, but your player will correctly read the 16:9 flag and display it as widescreen, with black bars on top and bottom.
If you are going to xvid avi, you'll probably want to use a resolution of 640 x 360 (assuming you want it to play on the tv, not just the computer).
Take a look at this discussion over at videohelp.com: http://forum.videohelp.com/threads/283886-XviD-Resolutions-PAR-DAR
By the way, jagabo and Baldrick over at videohelp know aspect ratios much better than me and you'll find quite a lot of information there about this subject.