simple video editing (pc)

so we have a sony handycam. and it's nice and easy and takes relatively nice video. for under 300 bucks it was a good buy.

however, the wife wants to edit together "best of" type stuff. great idea. i do all my multitrack audio in a multitrack video editor and production suite! how fortuitous!

sadly vegas does not like this particular .mpg format and says "no, there is no audio attached". super-sadly, this will not suffice as we need audio for all the yelling and crying and gnashing of teeth and whatnot.

i have yet to be able to locate a decent freeware solution, and premiere is out of my budget. anything i've overlooked?