Crashed & Burned (Colored screen and kernel panics and bad times)

My in-laws iMac just crashed and burned. It's an older aluminum (2008?) 24" iMac and I just put Lion on it, although I don't think it has anything to do with it. They said the screen suddenly went crazy with streaks of red that overtook the screen. Now when I try to restart it it never gets past the spinning gear...it just freezes.

What's strange is that there are yellow specks across the gray screen, but they turn blue when going across the apple logo. (I tried to attach a picture but that isn't working at the moment).

Here are the things I've tried:

Resetting PRAM (after resetting the PRAM, the colored specs on the boot screen changed their pattern. Weird)

Resetting SMC

Unplugging peripherals and restarting

Booting into Safe mode

I also tried booting into the install disc but that resulted in a kernel panic.

This computer has already had a hard drive crash, but for this I was thinking the logic board/graphics are completely fried. After the kernel panic, I was thinking it could be RAM related, but I've never heard of bad RAM preventing startup.

Any other ideas? Time for a new computer?