MS was knee deep in anti-trust negotiations with the DoJ around that time so I imagine acquisitions of that size and scope were off the table. Sega probably was small potatoes financially for MS at the time, but buying one of the three companies in that market wouldn't have helped their anti-competitive reputation.
Maybe. It's not like they didn't turn around shortly thereafter and launch their own console, likely incorporating lessons learned from their Dreamcast work.
Indeed, from the Wikipedia, article, MSFT had a fork of the OS to run DirectX games on it "Microsoft developed a custom Dreamcast version of Windows CE with DirectX API and dynamic-link libraries, making it easy to port PC games to the platform,[31] although programmers would ultimately favor Sega's development tools over those from Microsoft.[28]"
