Mp3 and DivX are no problems on WinUAE. WinUAE is much faster than any real Amiga (assuming a 1000+ MHz machine). There currently is no free player for AVI movies. The DivX codec of course is free, but you need to buy a player. Frogger is a good choice here.
http://frogger.rules.pl/IMHO OS3.9 would be a much better choice over 3.5. Now that both exist, 3.5 can be considered a beta version of 3.9. The 3.5 improvements are mostly internal, not visible to the user. Most functionality can be achieved by freeware from Aminet, too.
This is true for OS3.9, too, but OS3.9 is a quiete nice overall package. It contains internet programs, multimedia players and it can be installed in one go.
As a hint for OS3.5, you should first (before the actual installation), create an Emergency-Disk. This is not documented but heavily recommended. Then boot from the Emergency-Disk and install 3.1, 3.5pre and 3.5 from scatch. This is the best way to get a running system. There are some changes to the startup process and some obsolete programs that makes it difficult to upgrade a highly patched OS3.1.
With WinUAE it is very easy to maintain several configurations with different startup volumes, so you should leave your current (working) setup alone and create a new one for 3.5 at first. When familar with the installation process, you can still try to upgrade your existing setup.
And of course you do not emulate a 060 but a 040. UAE does not offer 060 emulation. There are some hacks that make programs *think* they run on a 060 but the actual processor is still a 040.
Bye,
Thomas