Previous efforts to derive lung progenitor cells from human embryonic stem (hES) cells using embryoid body formation or stromal feeder cocultures had been limited by low efficiencies. Here, we report a step-wise differentiation method to drive both hES and induced pluripotent stem (iPS) cells toward the lung lineage. Our data demonstrated a 30% efficiency in generating lung epithelial cells (LECs) that expresses various distal lung markers. Further enrichment of lung progenitor cells using a stem cell marker, CD166 before transplantation into bleomycin-injured NOD/SCID mice resulted in enhanced survivability of mice and improved lung pulmonary functions. Immunohistochemistry of lung sections from surviving mice further confirmed the specific engraftment of transplanted cells in the damaged lung. These cells were shown to express surfactant protein C, a specific marker for distal lung progenitor in the alveoli. Our study has therefore demonstrated the proof-of-concept of using iPS cells for the repair of acute lung injury, demonstrating the potential usefulness of using patient's own iPS cells to prevent immune rejection which arise from allogenic transplantation.