The error is due to the "xps" executable that could not be found. This message occurs if the EDK path is not correct and if an XMP project is added as a source in Project Navigator.
Check to see that EDK is installed and that the PATH variable is set correctly.
This issue is fixed in the latest 8.1i Service Pack, available at:
http://www.xilinx.com/xlnx/xil_sw_updates_home.jspThe first service pack containing the fix is 8.1i Service Pack 1.