Windows will not boot or function properly due to recent changes in hardware or system configuration.
Using Windows startup menu
The Last Known Good Configuration boot option uses Registry information and drivers saved at the last proper shutdown. Any system changes since the last proper shutdown are lost. Missing drivers or files necessary for operation of new devices will have to be replaced with proper versions. This is the next best thing to restoring the system to a prior system Restore Point and does not affect installed applications unless they involve device drivers.
Very little seems to be known about what precisely happens with the Last Known Good Configuration, but the simplest reference comes from Microsoft itself at http://support.microsoft.com/default.aspx?scid=kb;en-us;307852&sd=tech.