On Sat, 22 Oct 2016 10:54:57 -0700 (PDT), Chris Jenkins
wrote:

Yeah, option 1 seems to be the best answer, short of tearing out the walls of the
entire bathroom (very small room

If this was my project, I'd much rather replace all the sheetrock in a
small room than spend hours and hours trying to feather the mud to
match, and still have uneven walls in the end. When you take into
account the amount of time to apply all that mud and it's cost, it may
be cheaper in the end to just replace all the walls. After all, your
time has value too, and sheetrock is cheap.

Or, at least replace the sheetrock on the wall that adjouns the shower,
so you only have to match up an inside corner, and not the whole wall.
If I understand what you have there, it sounds like someone did a half
assed patch job, sometime during the past (roughly 60 years) since that
home was built, and now you have to try to match up to that messy patch
job.

Plus, if your tile will match the old walls, it will be noticably uneven
and require more tile cutting and "hack-work".