I was reading some articles over at Winrumors when it hit me , since the Zune HD player is "no more", what if Microsoft used a modified version of Windows Phone 7.5 on a new Zune device... like iOS for iPod and iPhone? They would be almost the same but without the phone on Zune device. Is it possible?

Provided they could get it to run (IDK much about WP7 so IDK if it would run) it'd be a pretty good idea I'd guess.

WP7 is based on Zune.

Yeah, so this should work. I'm not into the WP7/Zune thing, but if someone could make a custom firmware or MS themselves could release a firmware for it, it is entirely possible.

I've actually assumed the same thing. I could see Microsoft releasing a WZ7 or WZ7.5 (WindowsZune) device with all the features of WP7 but without the Phone stuff (basically no 3G, no Phone, No SMS\MMS).
I've also seen a proof of concept where someone used a HTC HD2 and a WP7 kitchen to roll up a non-phone WP7 (with all phone modules removed too to see about dependencies) and it worked just fine.