Proxy Auto config (PAC) exception

Let's try the easy ones first:

(In Internet Explorer; and I'm assuming you're using IE because you're running IIS on 127.0.0.1 and you reference the hosts file in \drivers\etc.)

1.) Navigate to "tools", "internet options", "connections", "LAN Settings".

2.) Make sure, "Bypass proxy server for all local addresses" is selected.

Now, hmm. Assuming you're running an internal DNS server/private IP addresses:

3.) In a command-prompt, run: "ipconfig /registerdns"

4.) Ensure that you can forward and reverse ping your machinename w/ it's internal IP address.

5.) If "localhost" isn't working, try pinging localhost at the command prompt, it's resolving to 127.0.0.1, yeah?

Let's clean up that hosts file:

5.) Make sure your hosts file wasn't inadvertently saved with a ".txt" extention. If so, remove it.

6.) In your LAN/adapter settings, make sure that you don't have any DNS suffixes to be appended.

Curious to see if any of those fixed the problem..

Think your DHCP options may be off... From: http://www.wlug.org.nz/WPAD

Add the following to your /etc/dhcpd.conf:

option option-252
"http://wpad.host.co.nz/proxy.pac";

With ISC DHCP v3+, option-# options don't work. You have to do this in the global section of your configuration:

option wpad-url code 252 = text;
(define a new option)

And add this in either the global or appropriate subnet section(s) of your configuration:

option wpad-url
"http://wpad.my.domain.tld/proxy.pac\n"; (use new option)

Also, you will find that auth in transparent mode in squid is not really possible. Some commercial web filters do work around this (indeed I work for SmoothWall, one such filter).