Hi, I would suggest you to use divx codec for compression which gives better quality and smaller file size.
One thing to note about Virtual Dub is that you have to specify codec for each video and audio separately. The avi files are not compressed one. so converting your files to avi is of no use.
I would suggest a mp3 compression for the audio with bitrate somewhat near 96 kbps and divx compression for video, which would surely give you smaller file size with better quality.
You could find divx codec with player on your Digit CD or DVD.