It seems to me you can't make a silk purse out of a sow's ear here, and it sounds like that Peugeot is not an all out mtb. If that's the case, I'd say forget spending money on it, and see if you can get a more mtb specific bike from ebay or craigslist (much prefer craigslist as no shipping is involved, but sometimes you find a bike on ebay in your area). You might be suprized what you can pick up for a couple of hundred dollars if you have patience and are willing to have eyes like a hawk. Look for something that has at least a 1 1/8" steerer and is threadless, it will enable you to upgrade eventually if you find the need too.

On the positive side, it's amazing what you can do off road on any bike (sleek ultralight racing bikes excepted). If you like riding off road, can't afford an mtb, just take the Peugeot off road and ride the heck out of it. So long at the frame is reasonable, the best thing to do would be get some good mtb tyres, adjust everything correctly and clipless pedals.

Those Nashbar frames are probably a fantastic value, but don't forget you still have to get all the components (if you haven't got them already) and fit them (got the tools, expertise or do you need to go to your LBS and pay for this?). Just my opinion, but I think that usually it would cheaper to go the used bike route than attempt to build up that Nashbar frame.