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 one week 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 bisected appearance. NPCs engrafted into spinal cords of JHMV-infected mice exhibited diminished migration velocities and increased proliferation compared to transplanted cells in non-infected mice. NPCs preferentially accumulate within areas of axonal damage, initiate direct contact with axons, and subsequently express 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.