Cobra Kai instructor John Kreese is now broke after he loses his students, who left the Cobra Kai dojo after Kreese attacked Johnny Lawrence after his loss to Daniel LaRusso at the All Valley Karate Tournament. Kreese was then stopped and humiliated by Mr. Miyagi. On the present day, Kreese visits his Vietnam War comrade Terry Silver, a wealthy businessman who owns a toxic-waste disposal business and is the founder of the Cobra Kai. After Kreese tells him about what happened, Silver vows to help him gain revenge on Daniel and Mr. Miyagi and re-establish Cobra Kai. Silver sends Kreese to Tahiti to rest and get his life back in order while he plans to avenge him.
Upon arrival in Los Angeles, Daniel and Miyagi discover that the South Seas apartment has been demolished, which puts Miyagi unemployed and leaving Daniel homeless. They also learn that Daniel's mother, Lucille, is in New Jersey taking care of her uncle. So Miyagi permits Daniel to stay at his house for a while. Daniel uses his college funds to realize Miyagi's dream of opening a bonsai shop. Miyagi thanks Daniel and makes him a partner at the bonsai business. When Daniel visits a pottery store across the street, he meets and befriends Jessica Andrews. Daniel has a brief crush on her, but she tells him that she has a boyfriend back home at Columbus, Ohio, but they remain friends.
Meanwhile, Silver hires a vicious karate fighter named Mike Barnes to defeat Daniel at the next All Valley Karate Tournament. Silver sneaks into Miyagi's house to gather information and overhears Daniel telling Miyagi that he will not defend his title this year at the tournament. Later, Barnes and Silver's henchmen attempt to coerce Daniel to enter the tournament. Daniel refuses and Barnes departs in a heated rage. The next morning, as Daniel and Miyagi are practicing kata, Silver interrupts and tells them that John Kreese suffered a heart attack after losing his students and asks for forgiveness for Kreese's behavior. Later, Barnes and his friends attempt to make Daniel sign up for the tournament. When Daniel again refuses to enter the tournament, a skirmish ensues until Miyagi arrives and fends off the three men. After driving Jessica home, Daniel and Miyagi return to find their stock of bonsai trees stolen, with a tournament application hanging in their place.
Daniel and Jessica decide to dig up a valuable bonsai tree that Miyagi brought from Okinawa and planted halfway down a cliff with the hope of selling it and using the money to replace the other stolen trees. As they retrieve it, Barnes and his men appear and retract their climbing ropes, leaving Daniel no choice but to sign up for the tournament. They get pulled back up, but Barnes breaks the valuable tree. Daniel returns to the shop with Miyagi's damaged bonsai, which Miyagi attempts to mend. Miyagi tells Daniel that he has sold his truck to buy a new stock of trees. Miyagi refuses to train Daniel for the tournament.
Silver offers to 'train' Daniel for the tournament at the Cobra Kai dojo. But Silver forces Daniel to destroy a wooden dummy meant to harm and weaken him. Throughout his training, Daniel's frustration alienates himself from his closest friends. While Daniel and Jessica are at a nightclub, Silver bribes a man into provoking a fight with Daniel. Daniel punches the man, breaking his nose and causing Jessica to storm out in disgust. Shocked by his aggressive behavior, Daniel apologizes and makes amends with Miyagi and Jessica.
Daniel visits Silver to inform him that he will not compete at the tournament. Silver reveals his true agenda to Daniel, and Barnes and Kreese enter the room. After Barnes viciously assaults Daniel, Miyagi intervenes and saves Daniel. Miyagi agrees to train Daniel. They train and replant the now-healed bonsai.
At the tournament, Barnes reaches the final round to face Daniel. Silver and Kreese instruct Barnes to inflict pain on Daniel and to keep the score a tie and then beat him in the sudden death round. During the fight, Barnes gets the upper hand. When the initial round concludes, a severely beaten Daniel tells Miyagi that he cannot continue, but Miyagi encourages him to carry on. In the sudden death round, Daniel does the kata. When a confused Barnes lunges toward Daniel, Daniel flips him to the ground and strikes him, winning the tournament and becoming the first person to ever win the tournament two years in a row. Disgusted and humiliated, Silver walks away from Kreese and people throw their Cobra Kai shirts back at him, implying that Cobra Kai is shut down forever. An over-excited Daniel hugs Miyagi in celebration.
Who is disgusted by Daniel's behavior when he punches a man at a nightclub, breaking his nose?
Jessica