Debug an Arduino project on AVR Studio 5 Simulator
Here is an Arduino Simulator.  There's a "Pro" version, which costs $5 now but will later cost $50, as well as a free version with a time-delayed startup but otherwise full functionality.

This isn't a way to debug on the AVR Studio 5 Simulator, but it offers similar functionality within its own IDE: 



According to the linked website, it includes the following features: 


Steps through the program line by line. If a new line is selected, the program will continue from that point.
Performs digitalWrite, digitalRead and PinMode for pins 0-21
analogRead for pins 0-5 and analogWrite for digital pins 0-13
Serial output data and input emulation for Serial, Serial1 and SoftSerial
Emulates LCD output
If,while,for loop functionality
Subroutines (multi-level) with arguments
View variables in real-time
Step Into, Step Over, Step Out of or AutoStep run mode
Ability to edit sketch or open in Arduino IDE
#include code
Undock output emulation Serial and LCD windows
Context-sensitive help


See the software datasheet for more information.