http://forums.iis.net/t/1187650.aspx has the answer. Setting the iis authentication to appliction pool identity will resolve this.
In IIS Authentication, Anonymous Authentication was set to "Specific User". When I changed it to Application Pool, I can access the site.
To set, click on your website in IIS and double-click "Authentication". Right-click on "Anonymous Authentication" and click "Edit..." option. Switch from "Specific User" to "Application pool identity". Now you should be able to set file and folder permissions using the IIS AppPool\{Your App Pool Name}.