Joe,
That doesn't sound like a Mach3 problem, more likely Ace Converter. I've drilled lots of holes with Mach3, and all were as they were supposed to be. It's been a long time since I used Ace converter, but I don't remember it having a drill function. So it is probably treating holes in your DXF drawing as circles to be milled on the line, making your 1/8" holes 1/4" diameter. Yes? Give the hole wizard in Mach3 a try.
John Champlain