VS2005: Assembly '<assembly>' is incorrectly specified as a file.
Solution 1:
Try setting the Build Action property of the source DLLs to None. It solved the issue for us.
Solution 2:
I was running into this problem myself.
This is what worked for me:
I had added an assembly as a reference and as an "Existing Resource." Deleting the file from the Solution Explorer, closing, then reopening the project worked.