Thanks Venkat,
There is some good info in this thread about the discussion, but somehow things got hot. Now, if we have to refer something, we can always go back to THX and see what they recommend.
THX recommends a viewing angle between the viewer and sides of screen as 40 deg or less. To get the min viewing distance, divide screen diagonal length by .84. By this, they recommend 60" screen size by seating distance of 6~9 ft. So, we can have any seating distance, its just that we then have some limits on screen size. Now, granted, there may be some people who would like to seat closer and won't mind (its personal choice anyways) but if we have to make a generalization, then I think THX is good place to start.
If we are using the projectors, then as we reduce the screen size, there are couple of issues that pop-up and we definitely need to consider those.
- The projectors have a specified range of throw distance (distance between front of lens and screen). Many of the projectors have ranges from 10 ft onwards for throw distance. For example, Mitsubishi HC4000 has throw distance from 10.5 ft to 25.3 ft. Outside this range, the projectors lens cannot get a sharp focus. If one needs to have a projector mounted at shorter length, then he needs to get a short throw projector, like Optoma HD20 which starts from 5 ft or so. Also, if I have to mount a projector, I would not prefer to have the throw distance near the specified range limit. I would keep it around the middle of the range, cause thats where the lens performance would be best. Most of entry and mid level projectors of today have plastic lens, so it does have some imperfections like barrel distortion, pincushion, chromatic aberration etc near their ranges. Those are within limits, but they are max at that point. Top of that, we are seating closer, then those imperfections would be quicker to notice.

- At the shorter distance, we have the screen size which is smaller. Now, if a projector is recommended for 120" diagonal, and if we use it for lets say 72" diagonal, there is going to be huge increase in light output. To judge it, we have to take the lumens of projector and divide those by area of the screen. At 120" diagonal, screen area is 45 sqft vs 15 sqft for 72". So, the light output at 72" will be 3 times more compared to 120". If one has to watch the movie continuously, viewer will get headache and definitely get tired after a while. Thats also has to be considered. Offcourse, one can use a neutral density filter in front of the lens and cut down the brightness. But it does need some consideration. Just for reference, cinema halls have 6~12 ft lamberts of light. At home many people prefer 12~16. Any more and there will be headaches from the brightness (some people will still be immune to it and can take more brightness)
- another aspect is cables and everything. We need to leave some space behind the projector and surrounding so that it cools faster and cables also don't have to bend a lot. Bent cables exert quite a bit of pressure on the connector ports like HDMI etc. we all know how fragile those are.
- Another aspect is acoustics. If the seating is right next to back wall, you will have loud levels as the lower frequencies are lingering around wall boundaries and corners. There is bound to be listeners fatigue after an hour of listening or so (unless one listens on very small volumes) Another aspect is, the sound from front speakers and the reflections of those from the back wall will reach the listener at the same time. There is bound to be muddying up of the sound, with no front soundstage, no separation between front and surround speakers.
These are the setup guidelines and one can still put the projector in a small room. Its just that one has to understand the limitations. Then either work around those limitations or live with those. Most of the Home theaters, audio setup etc have some limitations or other. We either live with them and find workaround. One has to decide whether s/he can live with those are not.
Hope this helps.