Starship sensors and scanners, even in the TNG era, often cannot pick up life signs inside a severely damaged space vessel ("Heart of Glory", "The Doomsday Machine" "For the World Is Hollow and I Have Touched the Sky") or on a planet if there is interference ("The Galileo Seven", "City on the Edge of Forever", "The Paradise Syndrome", "The Enemy"). Clearly starship life-form remote detection technology can fail, especially when applied from a distance.
The M-5 simply accepted Kirk's argument because, like the human mind of Dr. Daystrom, its attention was on prosecuting its war on Wesley's task force, not on meticulously verifying facts. M-5 "thinks like men", not like a stolid robot with an endless thirst for facts.
To call the dialogue between Kirk and the M-5 tie-in "decisive evidence that the entire crew of the Excalibur was killed by the M5" is a bit of a leap. Clearly, M-5 committed murder and wrecked the Starship Excalibur. And Kirk took a chance that the entire Excalibur crew could possibly have perished (something the wreckless M-5/Daystrom personality was not prepared to refute), but that does not conclusively prove that everyone aboard the Excalibur was killed.
Lest we forget Commodore Wesley's radio report to Commodore Enwright:
WESLEY [on viewscreen]: All ships damaged in unprovoked attack. Excalibur Captain Harris and first officer dead. Many casualties. We have damage, but are still able to maneuver. The Enterprise refuses to answer and is continuing attack. I still have an effective battle force and believe the only way to stop the Enterprise is to destroy her. Request permission to proceed. Wesley, commanding attack force, out.
Note that Wesley does not say that the Excalibur's entire crew has been killed. Instead, he notes the deaths of Excalibur's captain and XO, with a very general reference to many other casualties (presumably throughout the entire task force). At this point, if the entire crew of the Excalibur had indeed been verified as K.I.A., Wesley would have to expressly report it to Enwright. Wesley does not do so.
While it is entirely possible that Excalibur's crew could have been killed, and this would fit in with the basic premise of "The Ultimate Computer", the plot does not rest on all 400 Excalibur crewmembers dying. Instead, Kirk grabs Daystom far earlier when the casualties are just beginning and there is the threat of more:
SPOCK: Probably true, Captain. It works faster, thinks faster than we do. It is a human mind amplified by the instantaneous relays possible in a computer.
UHURA: Captain, visual contact with Lexington.
WESLEY [on viewscreen]: Enterprise. Jim. Have you gone mad? What are you trying to prove? Break off the attack! Jim, we have fifty three dead here, twelve on the Excalibur. If you can hear us, stop the attack!
UHURA: I'm sorry. I can't override M-5 interference.
WESLEY [on viewscreen]: Jim, why don't you answer? Jim! Answer! Come in, Jim!
KIRK [grabbing Daystrom]: There's your murder charge. Deliberate. Calculated. It's killing men and women. Four starships, sixteen hundred men and women!
Excalibur is hit again immediately after the above exchange, undoubtedly resulting in more casualties. But is it ever conclusively established that all 400 Excalibur crew were lost? No.
In fact, Kirk's visible relief and humor at the end of this episode would make much more sense if the Enterprise had been involved in an unseen rescue of Excalibur survivors between the time of Wesley's final order to cease fire and the Sickbay scene with Daystrom shown sedated. (It would also make sense if some of the Excalibur survivors had been transferred to Enterprise to restore Enterprise's systems so the ship could get underway; this would go a long way to explain how Kirk could so confidently plop down in his command chair on the Bridge and give his crew the order to get underway.)