Set those files to be readable, writable by Everyone and try again, if that works then work out what the IIS permissions need to be.
I think the installer actually uses getcwd and not what is in the settings file but I don't think that is causing your problem, if it is though you could find where getcwd() is called in the installer and replace it with the string of your path with forward slashes.
When IIS serves a page, it uses the IUSER_MACHINENAME as the user who does it. So, you need to grant IUSER_MACHINENAME read and write permissions to those files. Of course you will need to substitute "MACHINENAME" for the name of your machine.
Also, when it comes to back/forward slashes, windows doesn't care what you use, so I just always build my paths with forward slashes so that it will work on both linux and windows without any problems.
That's theoretically true. However, installing Vanilla on my xampp did result in an installation that didn't work. It produces errors looking like somewhere the \ were interpreted as escape character, resulting in messed up paths.