Diffinity is a free diff and merging tool for Windows with a focus on accurate and easy to read source code diffs.

It will compare the contents of two text files and show all differences line by line and also which individual characters/words that differ.

Diffinity Features:

Improved diffing quality for XML and c-style source code
Thumbnail view of all diffs
Differentiates between changed, removed and added lines
Instance highlighting - double click or search for a word to show all instances of it
Syntax highlighting
Supports Unicode and auto detects encoding (and warns if encoding mismatch)
Customizable interface
In-line diffs live updated as you type
Windows Explorer shell integration