Acquisition
Deepholme, in a 'discarded sack' down a hidden passage, together with the Bar of Soap. To open the passage way, go near the suspicious looking wall and activate the raised stone next to it in Deepholme. It is located in the south-west area.
Location
Deepholme
Trivia
The Bar of Soap and the Worn out Rock Hammer are references to the movie Shawshank Redemption.