DVDs played fine in my B&W at 400MHz with 512MB RAM in OS X. That was in 10.3.x but nothing should really have changed?
Skype requires a beefy CPU, as well as a decent slab of RAM, to work well as it has to transcode the audio stream on the fly, which hammers the CPU. A G4 would accelerate that significantly.
That said 1GB of RAM on a PowerPC OS X machine is a great boost.
I have a Radeon 9200 128MB Mac Edition in my B&W and it rocks my socks in OS X.
The 1GHz G3 upgrade is a bad road to go down as it slows the machines Front Side Bus to 66MHz from 100MHz. There is a G3 700 or 800 I think for the B&W that far outstrips the 1GHz for performance as it runs at the native 100MHz. The FSB speed dictates how fast everything communicates along the main bus of the computer - from PCI to RAM to hard drives - everything, so dropping 1 3rd of the speed really has a huge impact on overall performance, even if the CPU itself is faster. For OS X a slower G4 is as good as a lot of OS X's core technology is accelerated using Altivec. I have a 500MHz iBook G3 and a 500MHz B&W G4 both with 100MHz Bus and 768MB of RAM and the G4 leaves the iBook in the dust for everything in 10.4.x.
I lucked out because i got the G4/500 for my B&W cheap, but they can be found at lesser speeds for good money. I used to use my B&W for running Photoshop 7 and Illustrator 10 before I got the Mac Pro (and CS3) and it did a sterling job. It was a joy to work on.