Do i just plug them into my PC audio Out? (using a Z77 mobo with latest audio chipset) or plug them into my M-Audio 40 headphone out?
Or even yet...do i buy a DAC and go that route?
I think your soundcard has a 5 line outs, to connect to a 5.1 system.
The lime green line out connects to the 2.1 system you have. Line outs are not suitable for using headphones, so connect the M-Audio to this line out and use the headphone out from the M-Audio.