How to insert php echo on $output variable

echo runs immediately. It doesn't return anything. So your code is effectively running as if it was written like this:

echo wpfp_link();
$output = '<ul blah blah blah</ul>';
return $output;

Given you're dealing with wordpukepress, you probably want something more like

$output = '<ul blah blah ' . get_wpfp_link() . '...</ul>';
return $output;

As well, PHP is not resursively embeddable, as you have. This code will not work as you think it would:

<?php
echo '<?php echo 'foo' ?>';
?>

This will output <?php echo 'foo' ?>, not just 'foo'.

You can concatenate the string with .

$output = '<ul class="custom_code"><li class="custom_code">'.wpfp_link().'</li></ul>';

return $output; 

$output = '<ul class="custom_code"><li class="custom_code">'.wpfp_link().'</li></ul>';

return $output; 

definitely will works. BUT we sure that you don't use short php tags /or they turned on in php.ini

so all this should looks like:

function print_li(){
$output = '<ul class="custom_code"><li class="custom_code">'.wpfp_link().'</li></ul>';    
return $output;     
}

where wpfp_link returns a list with <li> tags.

Not sure if it works like this but you can try.

$output = '<ul class="custom_code">
 <li class="custom_code">'.wpfp_link().'
</li></ul>';
return $output;

Do it like this:

$funcout = wpfp_link();
return "<ul class=\"custom_code\"><li class=\"custom_code\">{$funcout}</li></ul>";