The 28 kDa epsilon subunit of Escherichia coli DNA polymerase III is the exonucleotidic proofreader responsible for editing polymerase insertion errors. Here, we study the mechanism by which epsilon carries out the exonuclease activity. We performed quantum mechanics/molecular mechanics calculations on the N-terminal domain containing the exonuclease activity. Both the free-epsilon and a complex epsilon bound to a theta homologue (HOT) were studied. For the epsilon-HOT complex Mg(2+) or Mn(2+) were investigated as the essential divalent metal cofactors, while only Mg(2+) was used for free-epsilon. In all calculations a water molecule bound to the catalytic metal acts as the nucleophile for hydrolysis of the phosphate bond. Initially, a direct proton transfer to H162 is observed. Subsequently, the nucleophilic attack takes place followed by a second proton transfer to E14. Our results show that the reaction catalyzed with Mn(2+) is faster than that with Mg(2+), in agreement with experiment. In addition, the epsilon-HOT complex shows a slightly lower energy barrier compared to free-epsilon. In all cases the catalytic metal is observed to be pentacoordinated. Charge and frontier orbital analyses suggest that charge transfer may stabilize the pentacoordination. Energy decomposition analysis to study the contribution of each residue to catalysis suggests that there are several important residues. Among these, H98, D103, D129, and D146 have been implicated in catalysis by mutagenesis studies. Some of these residues were found to be structurally conserved on human TREX1, the exonuclease domains from E. coli DNA-Pol I, and the DNA polymerase of bacteriophage RB69.