The movie begins with Zohan , a Mossad agent, on vacation at Bat Yam beach (Tel Aviv) attracting several women and capturing the attention of every beach-goer with his Hacky Sack prowess. He cooks fish in the nude (using copious amounts of hummus) for himself, his friend and several women. As he finishes cooking, an Israeli Defense Forces helicopter arrives, stealing him away from his presumed well-earned vacation.
During a subsequent briefing, Zohan expresses his displeasure about having his vacation cut short. After being heckled by his officer, he eventually agrees to do yet another mission of recapturing a key Palestinian terrorist, the "Phantom" , who had been freed by the Israeli government in exchange for a captured Mossad agent, plus an additional "to-be-named-later" spy. Later, as Zohan expresses his desire to leave Israel and become a hairdresser in New York City, his wishes are met with laughter by his mother and his father, who had fought in Israel's Six-Day War.
The disgruntled Zohan fakes his own death during the pursuit of the Phantom, who is tricked into believing he had killed Zohan. Zohan smuggles himself into a flight to New York City in a pet crate of two dogs named Scrappy and Coco. Changing his hairstyle into a 1980s Paul Mitchell's Avalon style and taking "Scrappy Coco" as a new alias, he sets out to pursue his dreams in the Big Apple.
Initially unsuccessful in getting hired at an upscale Paul Mitchell salon (as well as an African American salon and a children's salon), Zohan's military expertise earns him a new friend, Michael , who gives him a place to stay. However, Michael feels uncomfortable with Zohan's sexual activities with Michael's mother, Gail . Zohan's passion for 1970s disco runs him into a fellow Israeli named Uri , a Zohan fan who is aware of Scrappy Coco's true identity but agrees to keep it a secret. Uri introduces him to a block in lower Manhattan filled with Middle Eastern Americans, who are split between a Palestinian side and an Israeli side of the street.
Zohan attempts to land a job in a struggling salon of a Palestinian woman named Dhalia . After first only allowing the ostentatious Zohan to sweep floors for free, she eventually allows him to be a stylist after he pleases a senior lady with a satisfactory haircut and back room sexual service. Zohan's reputation spreads instantly among the elder women of lower Manhattan, who comment that "besides the sex, he gives a pretty good haircut." Dhalia's business booms, upsetting Walbridge , a corporate magnate who has been trying to force out all the local tenants on the block so that he may build a huge mall. Zohan brags to his colleague Claude that he has a big one, which is understood as big penis, but he meant big amount of pubic hair.
Eventually Zohan is identified by a Palestinian cab driver named Salim , whose goat Zohan had stolen after Salim threw his shoe at Zohan and spit in his face. Salim convinces his friends to help him exact revenge on Zohan. He rebuffs their advice to "let the professionals" take care of it because Salim wants the glory of killing Zohan for himself. He and his friends decide to build a bomb, but they are unsure how to do so. Thinking that they need "chemicals," Salim and his friends walk into a pharmacy and try to ask for liquid nitroglycerin. Hearing Salim's mispronunciation, the pharmacist instead presents Salim with Neosporin. Seeing that the Neosporin doesn't destroy Zohan's workplace, Salim reluctantly informs Phantom through a Hezbollah hotline. Now a successful fastfood chain owner, Phantom then pays a visit to New York to hunt Zohan down.
Meanwhile, Zohan realizes that he has fallen in love with Dhalia when he discovers that he has unexplainable erectile disfunction except in her presence. However, Dhalia rejects Zohan's feelings for her after he reveals he was formerly an Israeli counter-terrorist operative. Zohan decides to leave Dhalia and confront the Phantom in a Hacky Sack game. His fight is cut short with sudden news of the Middle Eastern block being attacked by racist white arsonists dressed in Arabic clothing. (The arsonists are hired by Walbridge to instigate an inter-ethnic riot between the Israelis and Palestinians and hopefully allow him to take over their stores more easily.)
As Zohan and Phantom are working together to save the block, Dhalia appears, revealing that she is the Phantom's sister – or "Fattoush" as she calls him. Zohan's personal dossier allows him to discover the arsonists' true identities as rednecks hired by Walbridge. Zohan and Phantom lead the united Israelis and Palestinians of the block to save their shops, defeating the rednecks, thwarting Walbridge's plans, and damaging all of the shops on the block by using "The Sound" which is a combination of stereotypical Arabic rhythmic calling and stereotypical Hebrew "chhhh" sounds. The police arrive to arrest Walbridge for his crimes.
With the Israelis and the Palestinians united, the block is transformed into a collectively-owned mall, in which Zohan and Dhalia realize their dream, opening a joint beauty parlor. The Phantom also fulfills his lifelong passion of opening up a shoe store. The movie ends happily as Zohan's parents approve of his new wife (Dhalia) and hair salon, called "Dalohan," becoming customers themselves in a surprise visit.