I think i have a solution for this problem.
I had the same problem and looked around the internet for a solution, but nothing solved my problem. All the answers suggested testing the usb stick on another computer or using the disk management to assign a new drive letter, but these procedures didn't solve my problem.
I had Daemon tools (virtual CD) previously installed on my system, and the installation was corrupted. I think it was after i repaired windows using the repair procedure from the original CD, which actually installs windows again over the existing one. After that Daemon Tools stopped working, disappeared from the "add/remove programs" list, but somehow stayed on the system and caused trouble...
I think what was causing the problem is not Daemon tools itself (i used ver 4.0.3), but the ScsiPassThrough-driver (SPTD) that is installed with it (ver 1.25). Someohow it confuses windows with the drive letters. (according to daemon tools "SPTD is also used in some proprietary security, antivirus and monitoring applications...") so maybe you could have the same problem even if you don't have daemon tools installed. Anyway, you may want to try these steps anyway, they might solve your problem.
i couldn't re-install daemon tools, since i got error when installing the sptd driver.
How to fix the problem:
1. download the stand-alone sptd driver from here:
2. start the computer in safe mode.
3. click start->run... browse and select the installer from where you saved it, and add the word remove at the end of the line (so you will have something like (in my case i placed the installer on the desktop):
"C:Documents and SettingsUser01Desktopsptdinst_x86.exe" remove
and click ok.
restart the computer normally.
After i did this, i plugged in the usb stick and VIOLA! it works!
You should be able to reinstall daemon tools if you wish to. If you still have problems with installing it, restart the computer again to safe mode and do the following:
4. repeat step 3 but change the word "remove" to "add" like this:
"C:Documents and SettingsUser01Desktopsptdinst_x86.exe" add
and click ok.
5. restart again normally and install daemon tools.
I hope it helps...