Looks like you got it wrong.
For using update-alternatives you have to inform it that you got a new java version:
sudo update-alternatives --install "/usr/bin/java" "java" "/usr/local/java/jre1.7.0_40/bin/java" 1
sudo update-alternatives --install "/usr/bin/javac" "javac" "/usr/local/java/jdk1.7.0_40/bin/javac" 1
sudo update-alternatives --install "/usr/bin/javaws" "javaws" "/usr/local/java/jre1.7.0_40/bin/javaws" 1
And set that version as the default one:
sudo update-alternatives --set java /usr/local/java/jre1.7.0_40/bin/java
sudo update-alternatives --set javac /usr/local/java/jdk1.7.0_40/bin/javac
sudo update-alternatives --set javaws /usr/local/java/jre1.7.0_40/bin/javaws
Also, you may want to edit you /etc/profile to add java to the PATH, although maybe the Oracle installer already did that for you.