Microsoft has offered to buy Yahoo in a deal worth $44.6 billion (£22.4 billion), reported BBC News.
The offer, which is a mix of shares and cash, is 62 per cent above the price Yahoo's shares closed at on Thursday.
Yahoo announced on Wednesday that it would be shedding 1,000 jobs this month after it saw a 23 per cent drop in profits. Operating income at the firm also tumbled, falling 38 per cent during 2007.
Microsoft is currently the second largest player in the online advertising arena, behind Yahoo, which is second. The firm has been try to compete with market leader, Google but has so far had limited success.
Speaking in a conference call, Microsoft's Kevin Johnson said that the combination of the two companies would see a firm emerge that can realistically challenge Google for position as market leader.
"Today the market (for online search and advertising) is increasingly dominated by one player.
"The combined assets and strong services focus of these two companies will enable us to achieve scale economies while reaching R&D critical mass to deliver innovation breakthroughs," he added.
In the letter to Yahoo, Microsoft's chief executive Steve Ballmer said: "Today this market is increasingly dominated by one player. Together, Microsoft and Yahoo can offer a competitive choice while better fulfilling the needs of customers and partners.
"Together we can unleash new levels of innovation, delivering enhanced user experiences, breakthroughs in search, and new advertising platform capabilities. Many of these breakthroughs are a function of an engineering scale that today neither of our companies has on its own," added Ballmer.
Google currently holds around 58 per cent of search the related advertising market. Yahoo in contrast holds 23 per cent, while Microsoft holds just under 20 per cent.
The combined company would control over 40 per cent of the market.