College students who took advantage of a “deal too sweet to pass up” have run into a bit of trouble.

The $29 electronic version of Windows 7 Home Edition sold for Microsoft (MSFT) through Digital River (DRIV) doesn’t seem to install properly on some 32-bit Vista machines.

Apparently the download files weren’t properly packaged and when some users tried to “unload the box” they got an error that read:

“We are unable to create or save new files in the folder in which this application was downloaded”

A discussion thread with that title was begun on Microsoft Answers‘ Windows 7 install forum less than 3 hours after the new operating system launched. By Saturday morning it had generated more than 500 replies and been read nearly 44,000 times.

Microsoft acknowledged the problem Thursday evening and by Friday was reportedly offering refunds. Meanwhile, however, Microsoft technicians are pointing users to a five-step Download Squad workaround (pasted below the fold) that might be enough to send students screaming to the nearest Apple Store.

Any bets on how long it will be before the incident turns up in an Apple (AAPL) Get a Mac ad?

[Follow Philip Elmer-DeWitt on Twitter @philiped]

From Download Squad:

So you’re a student who has taken advantage of the crazy upgrade deal from win741.com but instead of looking at a nice, shiny ready-to-install ISO of Windows 7, Digital River sent you a handful of random files and no ISO! Fortunately, it’s very easy to turn them into an installable ISO! Follow this very quick guide to get Windows 7 installing right away.

To start with, make sure your downloaded Windows 7 files (the ‘expandedSetup’ directory) is unzipped into C: — it’ll make things easier later.

1. Download this tool — alternatively you can obtain the official pack from Microsoft, but that’s a whole darn gigabyte.

2. Unzip and move oscdimg.exe to your System32 directory (likely to be C:WindowsSystem32)

3. Open an elevated command prompt. In Vista you do this by typing ‘cmd’ into your ‘Start Menu’ and hitting ctrl+shift+enter. In XP, just type ‘cmd’ into the Run dialogue (Windows Key+R or from your Start Menu).

4. Type (or copy and paste) the following into your command prompt (this will vary a little, depending on where you’ve put your expandedSetup folder):

oscdimg.exe –u2 –b”C:expandedSetupbootetfsboot.com” –h “C:expandedSetup” C:WIN7.ISO

5. Ta’da! You’ve got a burnable ISO!

All you need to finish the job is a good burning application like ImgBurn, CDBurnerXP, or InfraRecorder. For this particular task I’d recommend ImgBurn – then just right click the ISO file and start the burn from your context menu. Or launch ImgBurn and choose “write image file to disc” — your choice!

No DVD burner? If you have a 4GB USB flash drive handy, check out this app!