I added an XML file as an embedded resource in my class library by using the accessing the project properties in Visual Studio and then Resources | Add Resource | Add Existi
I found that this article explains nicely how to set this up: http://www.devx.com/dotnet/Article/10831/1954
One thing that may have helped in this case is using a different method for determining the location of the embedded resource.
I personally prefer this method over using the "Resources" tab because it allows me to use other tools to add resources to the project for inclusion on compilation. I don't have to use the GUI with this tool