I published a Kindle book that has 55 color photos in it. -no problems and the detail in the photos look fine in black and white on the Kindle 3 and 2 (can't say about the K1).
The formatting that worked for me was to add the jpegs in Sigil (and converted to mobi using Calibre). If I had the pictures embedded prior to importing into Sigil, it wouldn't work -but I never tried a PDF.
If I recall an ePub actually places the photos in a separate folder with links for the final product to access -although it LOOKS as if the photo is embedded in the endproduct.