Welcome to Merlin's House of Mystery. If you're having trouble with this crazy quest, this is the place to come for help.
I'd like to iterate that I am not much of a FAQ writer and I do not aspire to be one. I do not care to adhere to any accepted rules of FAQ writing. I simply write down the information people need to get them through the game or help them with a particular problem, and that's it. I won't include a bunch of expository crap.
To get to the point, I will present this as a step-by-step walkthrough (similar to how I did my Jurassic Park guide). Although there are times when you can do things slightly out-of-order (for example, when collecting a number of items that are lying around in the woods for Merlin or someone else, it is not necessary to collect them in the exact order I give you), but it is generally recommended that you stick fairly close to this sequence of events because if you get too far ahead of yourself, it is possible you can become stuck with no way out other than to reset and start from an earlier password (or save state, you emulating kiddies.) Sometimes, items will not appear if you go too far too soon. (I have heard of people becoming stuck because one of the pieces of the Staff of Rhiothamus failed to appear, though I am not 100% sure this is the reason why.) So, be cautious and deviate from this guide at your own risk.