ISSUE:

When opening Excel files from PeopleSoft or SAP, users are prompted to enter username/password. 

It is not possible to enter correct credentials because user does not have access to those folders

If the Cancel button is selected then file is opened as read-only.

CAUSE:

Office cannot determine if the file can be authored on the webserver or not due to invalid responses to the OPTIONS and PROPFIND WebDAV calls made by the Office application and/or the webclient service.

This does not occur when using Mozilla Firefox, nor did it occur with computers running Office 2003 on Windows XP.

  
RESOLUTION:

Configure the server to respond to the OPTIONS and PROPFINDS WebDAV call with a 405 (Not allowed).
 

NOTE: Another solution is to disable the WebClient service in its entirety. However, this will be problematic if you use both PeopleSoft and Sharepoint are in the same environment. For Sharepoint, you want the webserver to process the WebDAV HTTP methods issued by Excel. For PeopleSoft, you do not.
 
Another solution recommended by Microsoft is to disable the OPTIONS and PROPFIND methods on your webserver if WebDAV is not applicable.

This is fairly straightforward for IIS. However, it is not so simple when dealing with PeopleSoft (Weblogic or Websphere).

For these PeopleTools releases, the OPTIONS and PROPFIND requests return a 200 and/or 302 code rather than 405. Despite a valid return code of 200, the response content isn't what Excel is expecting. Thus, it continues to throw an authentication dialog.