Neural precursor cells (NPCs) offer a promising approach for treating demyelinating diseases. However, the cellular dynamics that underlie transplanted NPC-mediated remyelination have not been described. Using two-photon imaging of a newly developed ventral spinal cord preparation and a viral model of demyelination, we describe the motility and intercellular interactions of transplanted mouse NPCs expressing green fluorescent protein (GFP) with damaged axons expressing yellow fluorescent protein (YFP). Our findings reveal focal axonal degeneration that occurs in the ventral side of the spinal cord within 1 wk following intracranial instillation with the neurotropic JHM strain of mouse hepatitis virus (JHMV). Axonal damage precedes extensive demyelination and is characterized by swelling along the length of the axon, loss of YFP signal, and transected appearance. NPCs engrafted into spinal cords of JHMV-infected mice exhibited diminished migration velocities and increased proliferation compared with transplanted cells in noninfected mice. NPCs preferentially accumulated within areas of axonal damage, initiated direct contact with axons, and subsequently expressed the myelin proteolipid protein gene, initiating remyelination. These findings indicate that NPCs transplanted into an inflammatory demyelinating microenvironment participate directly in therapeutic outcome through the wrapping of myelin around damaged neurons.