There are several programs that are recommended for avi to dvd conversion. ConvertXtoDVD is a good commercial program, but one of the best ones is free, and is called AVStoDVD. http://www.videohelp.com/tools/AVStoDVD AVStoDVD has two different mpeg2 encoders included. I prefer the HC encoder over Quenc.
AVStoDVD can create a dvd with a menu. It will also automatically make chapter points for you in the dvd. You can turn off auto chapter creation however and make your own if you wish. Menu creation within AVStoDVD is not really very sophisticated however, and I believe you can only create menu links to titles, not individual chapters within the dvd.
What you are really talking about are two different processes. The first is conversion of avi video to mpeg2 that is compliant to dvd-video specifications. The second process is called authoring, and this puts the mpeg2 video and audio streams into the necessary form to play on a dvd player. If you need more control over the authoring step, it is possible to use a pure authoring program.
There are some free programs for authoring, like GUIforDVDAuthor, which should have more options in building your dvd-video. GUIforDVDAuthor requires separate video and audio streams that are already converted to dvd-video specifications. AVStoDVD can convert and output as separate streams if you wish to use it for that purpose.
When I need a more complex menu for a dvd, I use a rather expensive commercial program called DVDLab Pro. It can take mpeg2, dvd-video or separate streams as input.