The current generation of ATRAC is "better" than CD. I say "better" simply because it's a bit subjective... for final material, it's better than CD due to it's 48kHz FR, and far better algorithm in the current version... BUT... it is a lossy system, and like any lossy format, shouldn't be used DURING the production/mixing process unless ABSOLUTELY necessary. I'd say MD is approx equal to a 320kbps++ mp3... but due to differences in algorithms, one may sound better with certain types of music over the other.
I've also heard that toslink into an MD sounds better than the original CD... I highly doubt it, unless the MD player is inherently better than the CD player to begin with... then that's a playback issue... not a format issue. The Toslink would just copy the audio... there may be some slight "air" added with the upsampling to 48kHz, but I'd say that would actually degrade the audio unless the sampler is really good. But I have noticed that most consumer MD recorder/players are built to higher standards than consumer CD/MP3 players. So maybe this is what your friend notices.
I wouldn't use MDs for mixing... only as a recorder back-up, or for informal recordings... but with the advent of straight-to-wav/mp3 recorders... it's just not practical to use MDs anymore. Anything that you'd want to record on an MD, is probably better off in a 44.1/16bit WAV/MP3 recorder now... a lot of digital recorders have line-in, and can record direct to mp3 anyway. That's good enough for emailing demos. Anything else... record in wav.
I have to admit though, I still love my portable MD recorder... it still catches more attention than any mp3 player, and the discs just look cool! Hehehehe.