I would like to know if one can extract an ISO into a folder and then add an entry into the bootloader pointing to initrd and kernel and boot into this linux distro? I know booting into linux ISO mounted as loop device is possible but I could not find a way to extract ISO or copy installed system into a folder and run that OS.
You ca point to a different kernel, but the whole operating system relies on components being installed at certain absolute paths. You'd have to rebuild the whole system to change all those paths -- a job for a lifetime.
You may be able to achieve your goal by using
chroot, but you can't directly boot into that system. You need at last some minimal boot system and then run everything else in you unpacked distro with
chroot. Or will a VM solve your needs?