UPDATE: This "projection" idea has greatly expanded with the advent of LCD projectors and YouTube video content. See the article describing the technique.
A variation on this overhead projection idea...
Kids create background transparencies and special Bible character transparencies and project BEHIND a student(s) or "over" the students who stand and act in the projected light. Read the Bible story aloud as they interact with their transparencies. Humor is a good influence and help here! To them, it seems like purposeful play.
Put projector on floor so that it doesn't appear directly behind students.
OR...find a thin somewhat transparent but slightly opaque plastic sheet and hang from ceiling. Then put overhead projector BEHIND the sheet ...in effect creating a "rear projection." Pretty simple really, and the kids enjoy seeing themselves interact with each other and transparencies.
This method can also be used to create shadow puppets which the "live" actors can interact with. For example, a cut-out of waves can be moved back and forth across the projector to simulate waves. Or a cut-out or drawing of Jesus can be projected next to a kid.