Back in the command line, issue the following command:
make extcoff
No error should occur, and a file name demo.cof should be created (along with many other files).
Now, start up AVR Studio 4.08 (in ``Atmel AVR Tools'' from the Start menu). Click ``Open'' from the opening screen, then look for the file named demo_cof.aps (the extension .aps) may not show. You can now run the program step-by-step using the similator.