It's hard to do that sort of thing correctly. If you take a car with 150hp, and end up with it having 700hp, it obviously can't be in the same class as it was before, so it goes up with the higher hp cars. But, the car wasn't designed with that much hp in mind. So you need to also get new suspension, definitely better tires, and whatever other handling upgrades you can throw at it. Even then, it maybe be possible that a car designed from the ground up with that much power or even less will still beat it around the track.
There's a point at which upgrading a car further can have a detrimental effect. If you can only fit a certain size tire on there, and it can't hold the power you're putting down at full throttle, it's not worth giving it more hp, since it'll probably end up being slower. The same thing is true in real life, sure you could probably make a mini have the same power, and do a lot of suspension work to help it, but I'm not sure you could really make one competitive against a supercar. I think that's the point they try to show you by raising the class, then when you race against other cars in that class it's so hard.
Sure, in real life, with enough money, you can turn anything into a badass track car, but a game simply can't account for everything.
In forza 2, I have taken D class cars, and make them into very good B class cars, sometimes even an A in one case, but it's not easy. I think one or two classes up isn't a big deal, but if you try to put a lower class car into the S or R class, It probably won't do very well. IIRC, there were certain cars that were better than this than others, I remember seeing time trial contests online where they'd restrict you from using certain cars because they had too much of an advantage.
Of course, I have no idea how Forza 3 handles this, but I'd assume it'd be similar.
