Translation:Last week, I called my Japanese friend on the phone.
Nihon de - you are in Japan in general, the general area of Japan - you're not pointing out where you are in Japan specifically or pointing out specifically that you are in JAPAN as opposed to some other country. Nihon ni - you want to specifically point out that you are in the country of Japan, as opposed to perhaps another country.
Where to start? I offered: " I called a Japanese friend on the telephone last week." , which may not be the most elegant translation, but in essence is correct. Nevertheless, it was rejected as a proper answer. The given answer however, is ridiculous. 日本の友だちい literally: "Japan's friend", which I suggest is best translated as "a Japanese friend " is not the same thing as "my friend in Japan". In the original sentence there is no direct indication that the friend is indeed in Japan, but it does do more than to suggest that he is 日本人 . If that is what was intended and for the avoidance of doubt, it would probably be better phrased as わたしの日本に友だち . On that (mis) construction there is no particular reason why the friend should be "of Japan" i.e. Japanese, but he would at least be in Japan. While I am at it , why is "phone " preferable to "telephone"? I know that this is in beta, but this is starting to feel as ropey as all Hell.