The Wall Street Journal reports that Steve Ballmer's company plans to work with Silver Lake Partners and the Canada Pension Plan Investment on the bid for Yahoo, which is thought to be worth around $20bn (£12.8bn).
"Under the proposal being discussed, Microsoft would put up several billion dollars of funding, with additional financing being arranged by banks," the newspaper said, quoting unnamed sources.
Silver Lake and the Canada Pension Plan Investment would provide the remainder of the funds, although that would be less than Microsoft's contribution.
Rumours of a takeover of Yahoo have intensified ever since the struggling search engine giant fired Carol Bartz as its chief executive in September. This week, Yahoo reported a 26% fall in profits and a 5% drop in revenue in the third quarter of 2011.
However, Microsoft faces competition for Yahoo from a number of parties, including China's Alibaba, a proposal led by AOL's chief executive Tim Armstrong and a rumoured private equity coalition brought together by Jerry Yang, the co-founder and former chief executive who still sits on Yahoo's board.
Speaking at the AllThingsD conference in Hong Kong, Yang said that the company had not ruled out any possibilities as part of its strategic review.
"There are plenty of options for it to work and there are plenty of options for shareholders to realise that," said Yang when asked about the possibility of selling Yahoo.
Jack Ma, the founder and chief executive of Chinese e-commerce company Alibaba, also today reiterated his interest in buying Yahoo.
"If the board is willing to sell, I'm interested. They've just got to let us know," said Ma at the AllThingsD event.
Yahoo shares rose 3.04% to close at $15.94 on the Nasdaq in trading yesterday.