I was getting this error (as well as many many other Create new web site problems in vs2005/sqlexpress/winxp).  I seem to have created this issue when I had a development machine that was a part of a windows active directory network then was not (you know, recycling a development machine from, ahem, work).  I created a new folder called c:\web, then set the folder security permissions for that folder for full control of my login user account (not a domain account) as well as full control of the folder by ASPNET account.  After I did that, then I created my dnn402 site using a filesystem in something like c:\web\mydnntest.  Then I added the sql2005 database (Database.mdf, naturally in App_Data folder), renamed release.config to web.config then hit F5.  Told vs05 to go ahead and modify the site for debugging (I am developing after all). Then let it run.  After it did the install, clicked on the view my website thingy at the bottom of the install page.  It came up with the dnn page frame and lots of errors trying to load images it could not find, clicked login, watched unhandled exceptions fly and let them go, which seems to fail the very first time, but then clicked on home and everything comes up roses.  I can now login and goto town.  Good luck.

Ah.. well you see, I did not install or publish to any existing folder.  I created a new one entirely since iis does not care if you put the site in /inetpub/wwwroot or you put it somewhere else.  I did try putting it in some place before, as well as giving iis what permissions I thought it needed, but to no avail.  After a publish and creating a mapping, you may then want to right-click on default web site->all tasks->Check server extensions.  It comes up with a question (do you want to tight security...) I answered yes and then _private and some other mapped folders which I have always seen before were put in place.  Hope that helps