Stewart Watts, 32, bought the present for his 11-month-old daughter Poppy and opened the box for her to play with.
But he didn't see the knife and it was only a few minutes later that he reacted in horror as Poppy put the blade into her mouth.
Fortunately, Stewart reacted in time before Poppy could hurt herself.
Mum Gina Barratt, 24, who was in the kitchen at their home in Catterick, North Yorkshire, at the time said: "She put the blade in her mouth and that's when Stewart saw the shiny blade. He grabbed it off her and she carried on playing. She didn't really know what had happened.
"I was devastated and I felt sick. I just kept thinking what could have happened and what damage it could have caused to Poppy."
Soldier Stewart bought the children's toy set, which contained contained plastic tools such as a drill and spanner and came packaged inside a train-case, for £11.99 last week.
Gina said: "The kit is in a train set and all the tools are inside and there is spaces for them all to fit in. It's a knife with a long blade with cardboard wrapped around part of it.
"I just think it's really scary and with Christmas coming up, other parents might buy the same toy. Nobody knows what could be inside it. My main concern is the safety of my child.
"Luckily Poppy did not get hurt, because Stewart was with her, but she is at the age where you can leave her to play with things. She's always putting things in her mouth.
"The toy was all sealed up when he bought it. We looked on the cardboard on the back of the toy to check that all the tools were in it."
Poundstretcher said an investigation had been launched into the 'unfortunate incident'.
A company spokesman said: "We would like to apologise to Gina and her family. Our products are rigorously tested by the manufacturers and we are investigating how this unfortunate incident happened."
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