I've tried holding down the option key but only the Mac HD shows up.
What happens if you insert the CD/DVD into the iMac while Mac OS X is running? Can you start the installation from there? Can you see the CD/DVD in System Preferences > Startup Disk?
Can you try the same DVD in another computer.
Seems like it might be an issue with the DVD itself.
Is there any way of replacing the CD or should I buy a newer OS?
Is there any way of replacing the CD or should I buy a newer OS?