Thanks for Vinicius for the help in above comments.
This is what I did. I went to Programs and Features in Control Panel and uninstalled everything with the term "Visual Studio 2010". Then installed Visual Studio 2010 again. That's it. It worked. It created the Silverlight project with Silverlight 3. I also installed Microsoft Silverlight 4 Tools for Visual Studio 2010 after that and it created the project.