It has been reported that nanoparticles (NPs) prepared by hydrophobically-modified polymers could accumulate passively in the tumor tissue; however, their cellular uptake mechanism and intercellular trafficking pathway have never been understood. This study was designed to address these concerns, using NPs prepared by a hydrophobically-modified chitosan (N-palmitoyl chitosan, NPCS). Molecular dynamic simulations found that a degree of substitution (DS) of 5% of palmitoyl groups on its backbone was sufficient to allow NPCS to form NPs, due to a significant increase in the intra- and intermolecular hydrophobic interactions. With an increase of DS, there were more palmitoyl groups present on the surface of NPs which were then able to interact with the cell membranes. A greater extent of cellular uptake of NPCS NPs was observed with increasing the DS on NPCS. The internalization of NPCS NPs was clearly related with the lipid raft-mediated routes; with increasing the DS on NPCS, the caveolae-mediated endocytosis became more important. The results obtained in the intracellular trafficking study showed that NPCS NPs entered cells via caveolae and transiently localized to caveosomes before trafficking to the endosomal pathway. These results suggest that the prepared NCPS NPs may serve as a carrier for intracellular delivery of therapeutic agents.