I just tried in Visual Studio 2008 SP 1 and it worked. I dragged the file into the project, and I was simply able to type "favicon.ico" in the property pane.
Are you sure it's at the root level of your application? If you have it in a subfolder in the project it will require the full relative path (like "icons\favicon.ico").
Bob King
2009-03-16 20:57:51