Extensive research has focused on transplantation of pluripotent stem cells for the treatment of central nervous system disorders, the therapeutic potential of stem cell therapy for injured peripheral nerves is largely unknown. We used a rat sciatic nerve transection model to test the ability of implanted embryonic stem (ES) cell-derived neural progenitor cells (ES-NPCs) in promoting repair of a severely injured peripheral nerve. Mouse ES cells were neurally induced in vitro; enhanced expression and/or secretion of growth factors were detected in differentiating ES cells. One hour after removal of a 1-cm segment of the left sciatic nerve, ES-NPCs were implanted into the gap between the nerve stumps with the surrounding epineurium as a natural conduit. The transplantation resulted in substantial axonal regrowth and nerve repair, which were not seen in culture medium controls. One to 3 months after axotomy, co-immunostaining with the mouse neural cell membrane specific antibody M2/M6 and the Schwann cell marker S100 suggested that transplanted ES-NPCs had survived and differentiated into myelinating cells. Regenerated axons were myelinated and showed a uniform connection between proximal and distal stumps. Nerve stumps had near normal diameter with longitudinally oriented, densely packed Schwann cell-like phenotype. Fluoro-Gold retrogradely labeled neurons were found in the spinal cord (T12-13) and DRG (L4-L6), suggesting reconnection of axons across the transection. Electrophysiological recordings showed functional activity recovered across the injury gap. These data suggest that transplanted neurally induced ES cells differentiate into myelin-forming cells and provide a potential therapy for severely injured peripheral nerves.