One year after he was humiliated when Mr. Miyagi’s student, Daniel LaRusso, won the All Valley Karate Tournament, John Kreese has lost all his students, and must close his dojo. Kreese visits Terry Silver, a Vietnam War buddy, karate black belt, and millionaire, who illegally dumps nuclear waste, to reveal that he is quitting teaching. Silver refuses to hear it and promises he will get revenge against Mr. Miyagi and Daniel LaRusso. Silver sends Kreese to Tahiti to regain his confidence. Miyagi and Daniel return from a trip to Okinawa to find that the apartment house Miyagi manages is being demolished. Daniel’s mother has left to care for a sick relative, so Miyagi lets Daniel stay at his home while he attends college. Although Miyagi refuses to take Daniel’s college fund to start a Bonsai tree nursery, Daniel rents a shop. Miyagi agrees to open the business if Daniel is his partner. That night, Silver hires Mike Barnes, the “bad boy of karate,” to defeat Daniel at the next All Valley tournament, offering him a fifty percent stake in twenty karate schools he plans to open. The next day, Miyagi takes Daniel to bluffs overlooking the Pacific Ocean to collect pine tree saplings. He explains that few natural Bonsai trees exist. When Miyagi immigrated to the United States he planted one on a nearby cliff called the “Devil’s Cauldron” to let it grow. Daniel announces his intention of fighting in the Valley tournament, but Miyagi refuses to coach him, explaining karate is to defend one’s honor or life, not as a competition to win trophies. Later, Daniel goes to a pottery shop to order containers and meets Jessica Andrews. As they talk, Daniel notices a picture of her rock climbing. Jessica asks Daniel out on a date before he leaves. That night, Terry Silver breaks into Mr. Miyagi’s home and discovers Miyagi received a Congressional Medal of Honor while serving with the 442nd Regimental Combat Team, a unit composed of Japanese-Americans who served in World War II. Hearing Daniel and Miyagi drive up, Silver climbs into the chimney. Honoring Miyagi’s wishes, Daniel burns the tournament’s application in the fireplace. Miyagi and Daniel leave, and a slightly singed Terry Silver slides out of the chimney. Daniel meets Jessica for their date, only to find she has a boyfriend she plans to see when she goes home for Thanksgiving. As Daniel gives Jessica a tour of his store, Mike Barnes and one of Silver’s goons come in and warn Daniel if he does not fight in the tournament, there will be serious consequences. The next day, pretending he is a karate teacher sent by the masters of the "Cobra Kai" school in South Korea, Silver apologizes for Kreese’s behavior in last year’s tournament and asserts that Kreese died of a heart attack after losing his school. That night, Daniel and Jessica are eating at the shop when Mike Barnes and two goons kick in the door. Daniel refuses to sign the application, so the goons smash the shelves. Daniel kicks one in the head and Jessica takes another out by hitting him in the stomach with a pot. Barnes kicks Jessica in the chest, then beats Daniel. Miyagi appears and hurls him through a door into the street. The three hoodlums leap into a car and drive off. Later, Daniel and Miyagi return to their home to find all of their trees have been stolen. Fearing they will go bankrupt, Daniel decides to retrieve the Bonsai tree Mr. Miyagi planted at Devil's Cauldron to sell for thousands of dollars. Jessica gives Daniel a crash course in rock climbing and they rappel down the steep cliff and find the tree. As Daniel uproots it, Jessica slips. Daniel grabs her, dropping the tree into the ocean below. They rappel down to the rocks and grab the tree before it can be washed away. They notice their climbing ropes being yanked up by Barnes and his two goons who are on top of the cliff. Barnes calls out that the tide is coming in. Unless Daniel signs the application, Barnes will let them drown. Daniel signs and the goons pull them up. However, as they near the top, Barnes demands Daniel toss him the tree. When he does, Barnes snaps it in half. Daniel rushes the tree to Miyagi who binds its trunk with wire. He explains what happened, then asks Miyagi to train him. But Miyagi again refuses. The next day, Terry Silver drives up as Daniel and Jessica are jogging. After hearing Daniel does not have a coach, he offers to lend him a book on karate. Later, Barnes shows up at Miyagi’s home and attacks Daniel for calling police. Silver appears. Pretending not to know Barnes, he chases him off with karate kicks. He tells Daniel he is re-opening the Cobra Kai dojo and offers to be his trainer. For the next few weeks, Silver teaches Daniel how to injure his opponent with illegal moves. When Daniel balks, Silver uses Daniel’s hatred for Barnes to justify these extreme measures. When Miyagi presses Daniel on why he is pushing himself so hard, Daniel responds that if Miyagi is not going to help him, then he should leave him alone. The night before Jessica is to go to Ohio, Daniel takes her dancing. Silver “accidentally” bumps into Daniel. As they talk, a young punk Silver has paid, accosts Jessica. When the boy gropes her, Daniel punches him in the face, breaking his nose. Silver advises him to run before the police come. Daniel runs home to tell Miyagi about the fight and confesses he feels he is coming apart like Mr. Miyagi’s bonsai tree. Miyagi shows him the tree is budding and advises everything can if it has strong roots. Inspired, Daniel goes to Silver’s dojo to declare he is not going to compete in the tournament. He is shocked when Mike Barnes steps out of Silver’s office. Silver explains that unless Daniel fights, he will destroy him and everyone he loves. As Daniel tries to leave, Kreese jumps out, blocking his path. Barnes beats Daniel, then chases him outside. Barnes is hurled back into the dojo by Mr. Miyagi, who pummels the other two other men. While Miyagi is leaving, Silver screams he still wins as he and Kreese are opening dozens of dojos to teach their brand of karate. Miyagi agrees to become Daniel’s trainer. After weeks of training, Daniel and the Bonsai tree grow stronger. Daniel and Miyagi rappel down the Devil’s Cauldron and replant the tree. Miyagi explains that Daniel, like the tree, must choose how it grows. At the tournament, Daniel is the reigning champion and only has to fight in the final bout. So, he watches Barnes annihilate all his opponents. As Daniel finally steps up to the mat, the announcer asks the crowd to applaud for Silver who has bought the building so the All Valley Karate League can have a permanent home. Silver takes the stage and announces his new chain of karate schools and his partnership with Kreese. He then orders Barnes to beat Daniel bloody, but keep the score down so they will go into overtime where he can humiliate Miyagi’s student. Barnes easily scores, then deliberately loses a point by kicking Daniel in the crotch. For the next three minutes, Daniel takes a bruising with Barnes losing every point he gains. During the slight break before overtime, he begs Miyagi to let him quit. Miyagi tells Daniel that his best quality is still inside him, but he must let it out. Daniel limps to the line. Disregarding everything Silver taught him, he ducks a blow and flips Barnes to the mat for the point and victory. Daniel leaps into Mr. Miyagi’s arms screaming, “We did it!”