Instead of using the Merge feature, you can use the "Append copied PGC" function to have a seamless merge. The requirements are that disc 2's movie PGC must have the same aspect ratio, audio and subtitle streams as disc 1's movie PGC.
Here are the instructions for the Append copied PGC:
As for making one menu for the combined disk, you might be better off using an authoring tool that automatically creates a menu with chapter points for you. DVD Styler, Gui For DVDAuthor or any commercial package come to mind.
If you prefer to use the original menus from both disks, then you will have to copy the menu from disk 2 and add to disk 1, then make the necessary navigational adjustment to link the menus together and point to the appropriate chapter. It can be real simple or complicated. This all depends on the complexity of your menu structure.