Can I merge images onto the template that are stored on Google Drive?

Yes, you have a few options:
1) You can put your files in a public folder first (create a folder, right click Share-> Advanced->Change to Public), then you can get any file in a folder by entering URL in this format: https://googledrive.com/host/<folderID>/<filename>.
For example if you created a test folder on Google Drive and uploaded a file Test-Image.png, the Image URL is:
https://googledrive.com/host/0BwdB0jiqM9yCXzlGeDZjaUhYZFk/test-image.png
This is a URL that you want to populate into the Image URL field on Master Object and then use that field to merge on a template with image checkbox checked.

2) If you don’t want to put files in shared folder, you can use image that are uploaded directly to Google Drive (as long as they’re publicly accessible).
Image URL format will be: https://docs.google.com/uc?id=<file-ID>
Example:
https://docs.google.com/uc?id=0BwdB0jiqM9yCM01iekxpdlc4ZHc <https://docs.google.com/uc?id=0BwdB0jiqM9yCM01iekxpdlc4ZHc>