On Windows Server 2003 I am using a web browser (http://servername/site) to get to a web site on itself (servername) referencing an entry in the hosts.txt file - required for the use of the software. I am receiving the user authentication box ('connect to') box. Verified that the integrated windows authentication is unchecked in the IIS properties.
I can access this web site (http://servername/site) successfully from another Windows Server 2003 and Windows XP with the hosts.txt entry. I can also access a web site (http://servername1/site1) from servername with the servername1 entry in the hosts.txt file.
From this I can see that servername is utilizing the hosts.txt file. For the IP address I tried both the actual address and the loopback (127.0.0.1) address.