Hi - and welcome to the forum!
The fault seems to lie at the door of the Movie Factory files, since you report no trouble in compressing 'store bought' DVDs.
I wonder if I could ask you to use Movie Factory to create a very small example: a few minutes of footage and some chapter points with menu? The test should also include audio of the same format as in your larger example.
Try that with DVD2One and see what happens then.
If you still get the problem, redo the test but without the audio.
Let us know what happens.