Question about the I-130 Petition?

I can proceed with the application even though my wife is currently living in the United States on an expired visa?

Answer:
Yes you can. As long as it hasn't been too long.

Only problem is though she will not be able to re-enter the US if you travel outside, without parole papers (travel authorization)
until she receives her Green Card.

I would strongly advise not to even bother getting the travel papers, as without a valid visa, port of entry can still turn you away. Immigration HQ will tell you there is no guarantee.
So there is some cons of having an expired visa.
Yes. You can proceed with the I-130 and since she is in the US with an expired visa, you should ask that the case is seen in the US, not in her home country. If you want to get this matter over quickly, use the "fast-track" (express), although it is very expensive. USCIS charges $1,000.00 for it.

If you opt to file without using the fast-track, DO NOT submit any document using certified mail. Instead submit all documents using EXPRESS MAIL of the USPS.
After 6 months of being here on an expired visa she'll be banned from the USA for 5 years. If she overstays by 1 year or more she'll be banned for 10 years.

Since her visa is expired she CANNOT change status. She has no status to change.

You really, really need to speak with an attorney who specializes in immigration law.
Yes. She has to apply for an adjustment of status at the same time you send in the I-130 and affidavit of support.
Sure you can. It's the beginning of her journey to legal residency. Good luck :)
Yes, you can. Go to www.uscis.gov and they have a great forum where you'll find your answers. She can apply for a Green Card, it's a lot of paperwork and she shouldn't leave before that as she won't be allowed back to the US. The whole process takes around 6-8 months and if she hasn't comitted a crime or so, you don't need a lawyer. BUT I recommend a lot of reading on the topic. Good luck!

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