VLC does upvonvert - otherwise you'd see blocky artifacts when watching it at above 100%. I don't know if it does motion compensation and a lot of the other high-end upconversion features available in more modern DVD players, but I do know it has basic upconversion. Note that high end upconversion often includes correcting the framerate, deinterlacing if necessary, etc - which are more than merely making the image larger.
But a lot of those upconversion features are still protected by patents, so it's unlikely that you'll get them for free.