Many hours later I found this nifty program:
DIKO 0.77 It's a free DivX/XviD to MPEG2 encoder. Right now I'm playing around with it and it's easy to use and the results are great.
It uses FreeEnc 0.33 from the same site.
Another encoder is QuEnc
download from doom9. I tried it and it works too. Problem was that the original file wasn't standard DVD format so it converted it just fine but while authoring TMPGEnc DVD Author was unable to use it.
:thumbsup: