Check this article out: (S. McHenry is the son of notable BMW builder/racer Pete McHenry):
Modifying the M42 318iS Author: Stuart McHenry
This is a compilation of things that are necessary to get real performance out of the M42 engine that you use in a street/auto-x/mild track use car. These are items that will improve the cars performance and not sacrifice any low-end torque, which you want for street driving. These are all pretty much "bolt-on" mods, using the engines factory internals. If you want your 318iS to really fly on the street, these are the things you need to do:
Computer chip - This is a very basic and inexpensive modification for your car. Chips usually run about $200-$300 and are very easy to install. A chip on a stock M42 will bump the horsepower to about 145 (from 135) at the peak. The low-end torque is increased as well to improve everyday drivability. Though the real improvement comes at the top end; the chip widely increases the power band on the M42, from 4600-6000 to 4500-6700. I recommend Jim Conforti chips, as they are unarguably the best on the market for this motor, at a good price as well. On a side note, you will find the M42 makes a very distinctive "howl" from 6700-7200 rpm that reminds you that you’re driving an honest-to-God BMW. As far as chips go, I hear the best one for the E30 318is is the Mark D one from Canada. Make sure you are running good gas with these.
Flywheel - A major problem with the M42 was that it had BMW’s 'dual-mass’ flywheel; yes, it weighs almost twice as much as a 325i flywheel (as the name would suggest), at 28.5 pounds. This is a big problem and absolutely kills 1st and 2nd gear acceleration. Ever wondered why your 318iS’s 0-60 was so slow? Well, the flywheel is one of the reasons. There are 3 options to fix this: 1) use a 325i flywheel/clutch or 2) buy an aluminum flywheel for your M42's clutch, and 3) an aluminum flywheel for using the 325i clutch. Buying an aluminum flywheel for the M42 runs about $500-700 but is very light, and requires no modification to be fitted. M42 aluminum flywheels are about 12 pounds, and 325i aluminum fly's are about 8 pounds. The 325i flywheel requires a few other modifications to be fitted in the 318iS. Here’s what you need: 325i flywheel, 325i clutch, 325i pressure plate, 325i drive-pinion for the starter motor, and a ‘78-’83 323 throw-out bearing. Replace all these with the 318iS parts and it bolts right together. After all is said and done, your 318iS will have a LOT better acceleration in the first few gears, and deceleration will take place much quicker, which helps on the street and in the auto-x. Turner motorsport and a few other tuners also sell replacement aluminum flywheels for the 318is, but they also more expensive.
Rear end gear - The 318iS is equipped with a 4.10 limited slip from the factory, but you can do better. The desired gears out there are the 4.27 and the 4.45. You will find the 4.27 in E30 318i convertible 5 speed’s and the 4.45 is in E36 318i automatics. The 4.45 is a wicked, wicked street gear but will stick your RPM way up there on the highway. The 4.27 is a good compromise of performance and everyday use. It should be known that to make a 4.45 work, you have to swap the gearset into your E30’s differential, or find an automatic 318ti, which has a 4.45 and also has trailing arm rear suspension! So the E36 318ti 4.45 bolts right onto an E30, though finding an automatic 318ti with LSD may be difficult.
Adjust the cam timing - You know how on the E30 M3 you have to buy a $300 kit with adjustable cam sprockets to tune your cam timing? Not on the 318iS! The M42 is equipped with tunable cam sprockets from the factory. So pull your Cosmoline covered valve cover off and with the proper tools you can tweak your intake and exhaust cams up to 6 degrees +/- to provide more top end horsepower or more low end torque. See, you don’t have to blow a grand on a set of Schrick cams to make your M42’s cams a little hotter. The best setup is to adjust the intake cam to 5 degrees (advanced) and leave the exhaust cam alone. I would recommend having a shop do this work.
Muffler - The 318iS is equipped with a very free flowing exhaust manifold and center section with 2.25" stainless piping. The bottleneck in the system is the muffler. Thee are a few options for this. The first is a cat-back system, which replaces the piping and boxes behind the catalytic converter. Supersprint makes an excellent cat-back system that runs about $400. You can also simply replace the muffler. There are a variety of mufflers on the market but there is one that is very inexpensive, sounds great (not too loud, but throaty), and fits an E30 very well - it is made by Walker-Dynamax and is called the "Super-Turbo" muffler. It is available from Summit Racing at the price of about $40. We have had great success with these mufflers, and even use them in 3" size on our E30/S50 cars.
Intake system - The 318iS stock airbox works well, but a cone filter setup works better, but only if you have a well-built heatshield! Get a large K&N setup with the AFM adapter and all. Go to Home Depot, buy some Reflectex and build a "cool-air" system by cutting and fitting a heatshield. It is worth it in the end. While you are working on the intake, get the secondary plate of your throttle-body bored out 3mm to 57mm. This will make a difference.
In conclusion, with a little time, a little cash, and a little elbow grease, you can tune your 318iS to really perform. I know of one 318is with a properly built cold air intake, Supersprint cat-back exhaust, and Jim Conforti chip puts 131hp to the wheels on a chassis dynomometer. 131hp at the wheels is between 150 and 160 crank hp. With a lightweight flywheel, more aggressive gearing, and a couple of hundred lbs less weight, your M42 318is will have engine performance equalling or best a stock M20 2.5 liter 325i or 325is, with a more modern engine design (no more solid lifter valves and valve adjustments or difficult to access oil filter) and better fuel economy. Next time, we will talk more about other, more intensive engine modifications to the M42 engine such as hot camshafts (cams), headwork such as porting and polishing, headers, aftermarket exhausts, stroker kits, aftermarket fuel injection setups like Megasquirt etc, as well as chassis and suspension tuning.