I\'m creating a installer for a c# windows project using VS 2008. I\'m trying to write a custom action that copies a settings file from the source directory of the MSI file
I would recommend you to add the XML file to the installer as one of the components to be installed. That would be the easiest way and would not require a custom action.
WiX might be an option for you. It allows you to customize XML configuration files during installation using XmlConfig.