Software Deployment

If you are using AdminStudio, you can goto "Redistributables" section and right click and choose "Browse to Merge Module". After this you shoudl be able to see your MM in the list.
Another way to cross check is goto DirectEditor and check for COMPONENT or FILE tables and find out the merge modules entries. Name of the component or file will come with a guid such as "CompoentName.1233423...".

Once you include your merge module into your MSI, every thing from your MM gets merged into MSI Database tables and installation of MSI does everything. MMs are just redistributable which can be used with MSIs.

After this you shoudl be able to see your MM in the list. the OP already said that the MM isn't in his list. However, I presume IS is like Wise, in that you can browse to other folders?

Having said that, I did some research and found this MSDN article, Using Visual Studio .NET to Redistribute the .NET Framework http://msdn.microsoft.com/en-us/library/ms994427.aspx

Caution Deployment projects for applications that reference the .NET Framework automatically add a merge module (dotnetfxredist_x86_xxx.msm, where xxx represents the language code) in the detected dependencies folder. This merge module cannot be redistributed; it exists for internal use by the project to prevent individual .NET assemblies from being listed. It is excluded by default; attempting to include it will cause a build error.

Instead of adding the dotnet framework merge module; every client should have the .NET Framework as part of their standard client as it's a "system component". So distribution it as a separate package or use a bootstrap (wrapper) to handle the framework installation.