After figuring out the previous problem (DLL dependencies), I decided to install the .NET Framework SDK into the VPC image (a Windows Server 2003). No such luck: "Extracting file failed. It is most likely caused by low memory (low disk space for swapping file) or corrupted Cabinet file." No, not again a memory issue...
Wait a second! That image has 400 megs of memory assigned plus a 1.2 gig growth limit for the swap file. That can't be. As usual, I used Google to search for solutions. One (older) suggestion was to update Windows Installer - I gave it a shot anyways, and installed Windows Installer 3.0. No change, but that was expected. At least I am now up2date in that respect.
To spare myself further waste of time, I decided to take the easy route and ran
on my XP box, copied the extracted setup files to the VPC image - and presto! The SDK is installing like a charm.