The error itself asks if you've enabled the virtual directory and set it as an application.
Is that the case? Your web.config is in the file root so I would say no.
Regardless, have you double checked you've enabled applications, enabled the correct version of ASP.NET and ensured ASP.NET is permitted to run.
If they are all ok then I would recommend you next take a vanilla ASP.NET website/web application (I prefer the latter) and deploy it to that folder. Don't write any code and double check it works.
If it doesn't then the default web.config doesn't work. It could be an error with your machine.config or something similar. Personally I'd reinstall and re-register .NET. A sledgehammer approach!
If it does work, then your web.config may be corrupt.
These are all guess-timates but I hope they help out!
S