Apple TV works with a limited number of video formats. You can play clips encoded with the MPEG-4 (Moving Picture Experts Group) or H.264 video codecs at maximum resolutions of 720 x 432 pixels and 1280 x 720 pixels, respectively. This means you can play video from sources like the iTunes store and from YouTube, though in the latter case, those clips won't be true HD quality. You may notice that Apple TV doesn't support popular formats such as .AVI; you'll see later how limitations such as these caused many users to take matters into their own hands.
The Apple TV plays audio encoded with WAV, AAC, Apple Lossless or AIFF audio codecs. You can also use files encrypted with FairPlay Digital Rights Management technology, which is applied to all protected songs in the iTunes store. In addition, you can display photos saved as JPEG, BMP, TIFF, PNG and GIF image formats, meaning your HDTV will provide your treasured photos with a much larger stage than your digital camera's LCD or your computer screen.
For all of its capabilities, an Apple TV isn't an all-around media player. For instance, sans an optical drive, there's no way it will convince you to shelve your DVD player. And because Apple's business model encourages users to pay for TV and movie content, there's no DVR (digital video recorder) functionality.
You may wonder why you couldn't just mix and match similar hardware to create a setup that works like the Apple TV. The answer is that, well, you could, but it would be tough to assemble this collection of hardware for the price of an Apple TV. For instance, you could buy a Mac Mini, but that would cost more than an Apple TV and you'd have to deal with the overhead of buying a full-blown computer.
You could also just connect your computer directly to your TV, but only if you want to move your computer into the living room. If you own a laptop, you can connect it to your TV and play back your assortment of files. Your laptop will use a DVI connector, which won't look much different than video played through an HDMI connection. Like your desktop computer, though, your laptop isn't really a permanent part of an entertainment system.
You have other entertainment options at your disposal, too. Many people love the Roku, a media player that streams videos from Netflix, but that's the extent of this product's capabilities. The same goes for the direct-to-TV player offered by Blockbuster. A TiVo DVR will also let you stream Netflix to your TV, but you'll pay TiVo's monthly fee for these privileges.