OP, I think a basic Kindle would meet your daughter's needs beautifully. The new Kindle Fire is a tablet computer with a backlit screen, not an ereader. Unless you really want her to have full access to the internet and the App store, I'd say a Fire is more than you need right now. The basic $79 eink Kindle would be a much better choice for a 7 year old who wants to use it for reading.
I think you are asking about help for your daughter in sounding out a word she cannot read on her own, not a definition, right? If so, no, the Kindle won't help with that issue. Some books do have a "Text to Speech" function enabled, so the book can be read out loud for you,. But not on a word by word basis. However, as others have pointed out, the Kindle does have a dictionary function, so she could select the word and if she could read the definition by herself that might be helpful. Otherwise, it's just practice, practice, practice until she becomes a more proficient reader.
There are thousands of children's books available. I'm not sure what your budget is, but if you are willing to buy books for her you will never run out of selections. She'll be reading at a higher level/more advanced children's books long before she reads through the selection in her current age group.
You can also check out your local public library to see if it loans ebooks and if so, what their selection of children's books is like. And, of course, she can continue to check out and read paper books from her school library, too. Having an ereader is really the best of all worlds!!
I would second the suggestion of a cover, and of course as the parent you would make some rules about usage - whether it can be taken to school, how often she is allowed to purchase new books, etc. Once you activate the One Click with a credit card, you can load the account with gift cards and many parents do this as a means of keeping their children on a budget. The charges will be pulled from the gift card balance before the credit card is charged.
Personally, as a former children's librarian, I think a Kindle and a monthly book budget is one of the best gifts you can give a child, especially one who is already a reader. It will pay off for you down the road in reading comprehension, SAT scores, writing ability, etc. I think Kindles are fabulous - which is why I have every model!! All three of us got Kindle Fires for Christmas and they are fantastic!!