What causes this, is unknown. I believe it might be somthing to do with the OS's CD device drivers which just can't read the CD. Sometimes after installing some third party software (like Nero) the problem has dissapeared. Installing new drivers for your device can help as well, but they are rarely manufactured for Windows.

  Only solution known to have worked (many thanks Jhonny Walker for this):
  1: Download something to create *.iso files with (IsoBuster, WinISO - mostly shareware, but you can do everything with the free trial version and uninstall the application later).

  (You could now check maybe Windows can read CD1 and launch the setup without you having to proceed with next steps.)

  2: Create an iso file of CD1 somewhere on your hard-drive (this requires about 700MB of HDD space). If you get some errors, just ignore them.

Now you have two choices:
  3a: You could burn the iso file to a CD-R and run the game from that CD - should work.
  3b: If you don't want to waste CD-R's, or haven't got a writer, download Daemon Tools and install the application. Now there is a red lightning image in the right bottom corner of the screen. Right click it, choose Device 1 and Mount image - search out the iso file you created earlier and mount that. Daemon Tools creates a virtual CD device and uses CD image (ISO, BIN, NRG) files as CDs in it. Now install the game from there.