The Adobe Photoshop does not by default let you save a .png or .jpg file as .ico. To create a favicon you need to save the image file as a favicon.ico and place the favicon.ico file in your website.
To create .ico files in Photoshop you will first need to download the Photoshop plugin ICO (Windows Icon) Format. If you are downloading the Windows (32 bit) ICO for favicon, PNG, (Vista/W7) icons. Place the ICOFormat.8bi in C:\….\Program Files\Adobe Photoshop CS5\Photoshop\Plug-ins\File Formats.
You now will be able to save a .png file as favicon.ico.