What buddhism says about physical reality?

The idea in the question, namely: "The universe only exists inside this small body" is mixed up.

The Buddha said "the world (loka)" arises & ceases within the six-foot long body, including perception & mind. (AN 4.45)

The term "the world" refers to mental ideas of personal existence; both internally & externally. It is unrelated to whether physicality exists or not.

The idea in the question, namely: "The universe only exists inside this small body" is mixed up because assumes "the universe" is the stars, planets & galaxies rather than the mind-created world of self-identities & self-entities.

I imagine the friend acquired their idea about "the universe" from the translation of Thanissaro Bhikkhu, who translated "loka" as "the cosmos".

What "the world" ("loka") is is described in SN 12.44; namely, the arising or "birth" ("jati") of egoism, self-identifying & ideas about "beings" or "persons" that leads to suffering.

The buddhist concept of rupa, as well as the division of ayatanas as being internal on one hand, and external on the other, implies the idea that our perception of the world is not strictly solipsistic.

This suggest the Buddhist view that the ayatanas are mutually dependent, or “dependent arising”.

As you put it, this is one of the so-called 'unanswered questions', that is, you are really asking 'Does the world exist?'

Such questions deal with opinions, points of view, diṭṭhi's; and there is no way of holding one side of such a controversy without opposing the opposite point of view; there is no way of resolving the conflict; and such a state does not satisfy the search for truth. Such being the case The Buddha abstains from answering such questions because debates about existence and non-existence do not conduce to the ending of pain which is the fundamental point of what the Buddha teaches. You can see the futility of this sort of debate in the result of your discussion with your friend which only ended in incresing your confusion.

He who sees the origination of things cannot justify in mind the point of view that things do not exist; he who sees the ending of things cannot justify in mind the point of view that things have an ultimate reality.

What is the case is that the subjective individuality has identified with the six senses and once such an identification is made all perception is made relative to the input from these senses.

The eye comes into contact with a visible object and visual consciousness arises. Visual consciousness then becomes the sense-object of the mind sense.

So you see that subjective experience of the sight of a visible object is based on second-hand information. Since at this point your 'reality' is a construction made entirely by the subjective mind, that means that without escape from identification with the six senses, you have no ability to directly see whatever is 'out there'; there is no way to determine the truth or falsity of any claim that a thing exists. It is a hopeless situation, like a cat chasing its tail, and as such should be dropped as a waste of time.

Understanding this way of structuring the existing being, you can then see the logic of the statement:

"in this very fathom-long body, along with its perceptions and thoughts, I proclaim the world to be, likewise the origin of the world and the making of the world to end, likewise the practice going to the ending of the world. AN 4.46 http://buddhadust.net/backmatter/indexes/sutta/an/idx_04_catukkanipata.htm#p46

For 'the practice going to the ending of the world' see any good description of the Magga. I suggest: http://buddhadust.net/dhammatalk/the_pali_line/course/the10thquestion_2.htm#TheDestructionofthe%C4%81savas

As Thrangu Rinpoche once said, some people spend a lot of time arguing whether a chair really exists or if it only exists in our minds, but here we are much more concerned with our attitude to the chair. Are we attached to this chair? Do we hate this chair? Do we think we are the chair? Are we free from this chair? That's what really matters in practice, not whether it exists or not.

At the same time, as my teacher said, "reality is our interpretation". Here you go. The only reality we can know is reality we perceive in our mind, and this perceived reality is our own interpretation. Whether the physical reality exists or not, all we see is our interpretation.

So if in this interpretation there are any mistakes or gaps, but we attach to it as if it were truth, as if what we perceive in our interpretation were 100% objective reality - when we think like that we get into all kinds of trouble.

Like, we get attached to "the chair" or hate "the chair" - because in our interpretation it means something and we think that's the only truth. Then when someone gives us new facts about "the chair" - we don't accept them, because they don't fit with our reality, our interpretation. We only see what we know, what we believe, not what's really there. This is what's called "delusion".

So maybe you and your friend are both right. This is about "how we understand the universe" is different AND all that we experience is our own delusion.