Hi,
Have you resolved this issue? For the difference between the application and virtual directory , you can refer to this article:
Understanding Sites, Applications, and Virtual Directories in IIS 7.0
http://learn.iis.net/page.aspx/150/understanding-sites-apps-and-vdirs-in-iis-7/
If your problem persist, could you send the relevant IIS log entries here ? IIS log files located in the %systemdrive%/inetpub/log/LogFiles/W3SVC+n directory.