Your are not exactly paying for the engine alone. 1M use the same chassi, brakes, mechanical diff as M3. And then we have the bodykit and extra power.
It doesn't matter if it's got all the other stuff. Without the unique engine it's irrelevant and not a proper "M".
But I agree that M could have built the engine from scratch but BMW claim it would cost too much to develop and the price would be much higher than it is today. I dont think people would pay the price of a M3 to get a 1M.
Which is why they could have still built the car as it is now, but not call it 1M. By using the M badge they are setting their stall out for people to be disappointed when they realise it's got a mundane engine. By calling it a "tii" or something, people would still have been impressed but without the disappointment of it not having an M engine.
By using the M badge they are simply creaming off profits to the detriment of the brand. It certainly puts me off the M5. The reason is that I always thought of M as pure and not about profit at all costs. Sure, they need to make a profit, but they are ruining the brand with all the SUV M's, auto transmissions etc. This is obviously history. Therefore I can't guarantee the M5 will be buillt along the same lines and with the same ethos as other M models in the past.