Does anyone know how I can create an AVI with dolby 5.1 audio?

Your question is a bit unspecific, but I'll assume you're talking about the audio part only.
It mostly depends on what kind of material you have atm. You should be fine with a tool calles besweet (http://dspguru.doom9.org). It can transcode f.e. AC3 to ogg 6channel.
You would then need the ogg direct show filters (http://tobias.everwicked.com) to be able to create and use ogg as sound streams in your resulting file. To mux the audio and the video you could use virtualdubmod (http://virtualdubmod.sf.net). Find numerous guides and a large forum on the subject at doom9.org (http://www.doom9.org).

HTH.

Ok, My original audio files are 3 seperate stereo wav files. first is Front left and front right. Second is rear left and rear right and the third is center and sub. So technically, I have a seperate audio track for each of the 6 channels in a dolby 5.1 system. Our current player (a DVS player) can play the video (targa sequence) and 6 channels of audio (3 seperate wav files) simultaneously without problem.

I need to convert this into a self-contained avi movie without converting the dolby 5.1 audio into a mere stereo (2 channel) track. I need the avi to stream out all 6 dolby 5.1 channels.

I am unable to find an audio codec that supports multichannels and can be embedded into the AVI file format.

You mean you want to encode to Dolby Digital.
The encoder of besweet has very bad quality, the commercial encoders are much better. Very simple would be "Sonic Foundry Soft Encode", but it isn´t sold anymore. There is still ac3enc (part of Sonic Scenartist) and some others. Best would be to use one of them. AC3 can be muxed into avi without any problems.

Otherwise there are 3 other multichannel codecs, which allow you the same quality at lower bitrates (your file will be smaller):
-Vorbis
-AAC
-RealAudio
Vorbis only works correctly if use ogm or matroska for your movie. This are replacements for the old avi-container. This doesn´t affect your Video-Codec. You can still use DivX, XviD or whatever you like. For aac you can only use matroska. RealAudio works only rm-format (maybe in matroska), if you use rm you can only use RealVideo (RV9-EHQ has very good quality). If it works in matroska you can use any video codec you like.
For compatibility this doesn´t matter. If you use AC3 (Dolby Digital) as audio-codec most people have to install aditional software anyway. After installing DirectShow-Filters all formats are playable in DirectShow-based players (like Windows Media Player).

What about MP4??? :-P

Actually, I would recommend MP4 over Matroska.

I wouldn't at this point. There are no simple software or players for example for handling subtitles and many other things in mp4 yet, but the worst is the sync problem after seeking when using 3ivx splitter and either coreaac or 3ivx audio decoder. With Matroska everything is always in sync. And there will be a mkv->mp4->mkv converter, so there's no reason not to take advantage of Matroska now.

Thanks for everyone's input. Just to let you know.... I'm not ripping DVD's. This is for an immersive theater production and all of our material is original so I'm not worried about sync issues. I just didn't know if it were possible to have dolby 5.1 play from an AVI. (Our client cannot afford a DVS player)

about avi with ac3:

it doesnt matter if the material is original or not, when muxing divx video and ac3 5.1 audio into avi you will most likely see the sync issues at playback time, it is about some sort of moving sync (i would say it moves about +- 2 frames, prolly dependable on the way it is muxed), at least that is what i noticed in some of my tests (this might also depends on the playback machinery, the faster it is the better results you will get muxing the audio each frame instead of every 96ms for example). I guess the issue is about avi and vbr audio...

In my experience, AC3 sound will work fine inside the AVI container provided that it's muxed properly. I do this with AVI-Mux GUI. Every movie I've muxed with using this program works flawlessly, even when you switch between two different AC3 tracks while the movie is playing.