Now I figure theres gotta be 2 ways to do this.

1 - Merge the AVI's and convert to M2V and AC3
2 - Convert to M2V and AC3 then merge them together

Which way is easier, faster, and better? if either are possible i guess.

My guess would be #1 with VirtualDUB, but I couldnt figure how to go about doing that.
So basically I need to know how to merge 2 AVI's i think?

So it is the same movie in two parts??

To join 2 AVI's just use AVISynth:
Part1 = AVISource("part1.avi")
Part2 = AVISource("part2.avi")
return Part1+Part2

That is assuming that whatever program you are going to re-encode with can handle an AVS as input.

http://virtualdub.everwicked.com/index.php?act=SF&f=4

Sorry its a bit of a long link but it gets you to a Virtualdub forum that will answer all your questions.