Translation:The dolphin plays with a plastic penguin.
if you can merge the words "plastic" and "penguin" into the compound noun "plastic penguin" in English, then you can do the same in German, except compound nouns are one word in German. "Plastikpinguin" is perfectly fine and you can merge any nouns you want as long as it makes sense.
Like 'Plastik Pinguin'? Yes, that would be grammatically incorect. (Though many Germans also do this wrong, probably due to modern influences of the English language.)
In too-long-to-read words you can also add a - , especially if it is not an already existing word or consisting of non-German words. But I think in this case 'Plastikpinguin' looks better than 'Plastik-Pinguin'.