The function of the 102-amino acid C-terminal propeptide of surfactant protein B (SP-B) was analyzed by characterizing the phenotype associated with loss of expression of this peptide domain in transgenic mice. A construct encoding the signal peptide, N-terminal propeptide, and mature peptide of human SP-B (hSP-BDeltac) was cloned under the control of the 3.7-kilobase human SP-C promoter and injected into fertilized eggs of the FVB/N mouse strain. Founder mice expressing the hSP-BDeltac transgene were bred with heterozygous SP-B knockout mice (SP-B +/-). Offspring containing the transgene and one allele of mouse SP-B were identified and subsequently crossed to generate a transgenic line that expressed SP-BDeltac in a null background (SP-B(-/-)/hSP-BDeltac(+/+)). Expression of hSP-BDeltac in SP-B(-/-) mice was restricted to type II cells and resulted in a 2-fold increase in mature SP-B relative to wild type littermates. These mice survived without any evidence of respiratory problems and had normal lung function, normal alveolar surfactant phospholipid pool sizes, and typical tubular myelin indicating that the 102-residue C-terminal propeptide of SP-B is not required for normal structure and function of extracellular surfactant. However, proteolytic processing of the SP-C proprotein was perturbed resulting in the accumulation of a processing intermediate, Mr = 11,000, similar to the phenotype detected in SP-B(-/-) mice; furthermore, lamellar bodies in type II cells of SP-B(-/-)/hSP-BDeltac(+/+) mice were much larger than in the wild type animal and saturated phosphatidylcholine content in lung tissue was significantly increased although the incorporation of choline into saturated phosphatidylcholine was normal. Collectively, these results demonstrate a role for the C-terminal propeptide of SP-B in SP-C proprotein processing and the maintenance of lamellar body size. The C-terminal propeptide may be an important determinant of intracellular surfactant pool size.